GROUP REPORTING

10 September 2003 Antalya

Group Reporting Course Outline

- Related IAS standards

- Major consolidation concepts - Identification of subsidiaries, control concept - Subsidiaries that are exempt from consolidation - Investments - Joint ventures - Associates - Proportionate consolidation - Equity method - Intra-group balances and profits - Minority interests - Consolidation of subsidiaries abroad - Segment reporting

Group Reporting under IFRS Related Standards and Interpretations

Business Combinations IAS 22 Financial Reporting of Interests in Joint-Ventures IAS 31

Consolidated Financial Statements and Accounting for Investments in Subsidiaries IAS 27 Accounting for Investments in Associates IAS 28

Special Purpose Entities SIC 12

Consolidation Methods

FULL CONSOLIDATION
Subsidiaries

PROPORTIONATE CONSOLIDATION
Joint Ventures

EQUITY METHOD
Associates

Scope of IAS 27
Preparation and presentation of consolidated financial statements for a group of entities under the control of a parent Accounting for investments in subsidiaries in a parent's separate financial statements.

Definitions per IAS 27

A group = parent and all its subsidiaries A subsidiary = an entity controlled by another entity (its Parent) A parent = entity that has one or more subsidiaries Control = the power to govern financial and operating policies of an entity so as to benefit from its activities Consolidated financial statements = the financial statements of a group presented as those of a single entity. Minority interest = is that portion of the profit or loss and of net assets of a subsidiary attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by the parent

What is a subsidiary?
Control = the power to govern financial and operating policies of an
entity so as to benefit from its activities to the strategic decisions taken by management affecting the business, rather than the routine day to day decisions

CONTROL
P holds 50% + ordinary voting shares in S P holds < 50% ordinary shares, but still controls the financial/operating policies

What is a subsidiary?
How can P control the financial/operating policies of S when holding <50% ordinary shares?
Majority voting power by agreement with others Control by contract Power to appoint/remove the majority of the directors Power to cast the majority of votes at board meetings

CONTROL CONCEPT
51 % PARENT COMPANY A 10%

B 78 % 21 % C 12 %

(*) Ownership

percentages assumed to represent the control

Subsidiary B
Direct Interest: Indirect Interest: Effective Interest: Controlling Interest:

CONTROL CONCEPT
51 % PARENT COMPANY A 10%

B 78 % 21 % C 12 %

(*) Ownership

percentages assumed to represent the control

Subsidiary B
Direct Interest: Indirect Interest: Effective Interest: Controlling Interest: 10 % 39,78 % ( 78/100*51) 49,78 % 88 % (10 + 78 )

Example 1
In which of the following examples is there a Parent/ Subsidiary relationship?

(i)
Rainbow UK

Rainbow owns 45% of the voting rights for an investment in Yellow, but has an agreement with other shareholders (holding 20% of rights), such that the other shareholders always vote in the same way as Rainbow.

Yellow Ltd

(ii)

Rainbow owns 55% of the voting rigts in Yellow. For major operational and financial decisions in both Directors and shareholders meetings, the approval of 2/3 of the votes is required.

Example 1
(i)
Rainbow UK

Parent/subsidiary relationhips exist here. Rainbow has power over more than 50% of the voting rights by vitue of an agreement with other investors. Together with the other investors, Rainbow forms a control group.

Yellow Ltd

(ii)

No not a subsidiary. Rainbow does not have control over the operational and financial decisions of Yellow.

Mechanics of Consolidation
Accounting Policies
If S uses different accounting policies to P (i.e. local GAAP) accounts must be adjusted, or stated that the difference is immaterial

Accounting Dates

Subsidiaries accounting dates must fall +/- 3 months from the accounting date of the Parent. Significant transactions / other events must be adjusted for.

Consolidation
Consolidation = combining the accounts of the Parent and its Subsidiaries so as they are presented as one entity.

Start Consolidation
When control of S commences

Cease Consolidation
When control of S stops

Exception - A parent that is a wholly owned subsidiary (or virtually wholly owned) need not present consolidated financial statements

Exclusions from Consolidation

DISPOSAL LIQUIDATION MATERIALITY DISSIMILAR ACTIVITIES

3
6

S was bought and is being held solely for the purpose of resale.

No exclusion if S previously consolidated

Severe long term restrictions apply to the Subsidiary, which significantly impair Ss ability to transfer funds to P (i.e. liquidation)

No exclusion applies (but IAS apply only to material items)

Do not exclude 2 or more subsidiaries who together are material

No exclusion because Ss business activities are dissimilar from those of the rest of the group

Disposal/part disposal of subsidiaries

TOTAL DISPOSAL Control now <50% but >20% Control now <20%

Profit/loss on disposal = proceeds carrying value of net assets + goodwill

Consolidate pro rata Take profit/loss on disposal Continue to account under IAS 28, Associates

Consolidate pro rata Take profit/loss on disposal Account as a fixed asset investment under IAS 39

Disclosure
Accounting Policies

Statement of accounting policies used in relation to Subsidiaries.

List of significant Subsidiaries

Significant subsidiaries are listed stating their name, country of incorporation, the proportion of equity shares held, and if different the proportion of voting power held.

Effect of acquisition/disposal

The effect of the acquisition and disposal of subsidiaries on the financial position at the reporting date results for the period, and the corresponding amounts for the preceding period.

Expected developments from the IASB

Severe longterm restrictions control unlikely to exist Temporary control disposal intended within one year, not longer Intermediate parents exemption on preparing consolidated financial statements criteria tightened Minority interests presented within equity, but separately from parent shareholders equity Uniform accounting policies Disclosure changes

Scope of IAS 28
An associate is an entity in which the investor has significant influence (neither a subsidiary nor a joint venture)

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control over those policies (control defined as in IAS 27)

Significant Influence
Hold 20%+ voting power of the investee
(directly or indirectly through Subsidiaries) Significant Influence demonstrated by; Representation on the board of directors or equivalent governing body of the investee Participation in policy making processes Material transactions between the investor and the investee Provision of essential technical information.

Hold < 20%+ voting power of the investee

Interchange of managerial personnel

Substantial/majority ownership by another, does not preclude an investor from having significant influence

Significant Influence

The principle of Significant Influence still applies, even when the investor does not exercise their influence

Associates in consolidated accounts

Investment is held exclusively with a view to disposal in the near future Apply IAS 39 accounting for investments

Use equity method in consolidated accounts except when

Associate operates under severe long term restrictions

When to equity account in consolidated accounts

Equity Accounting Commences
At the date Significant Influence is gained

Equity Accounting Ceases

At the date Significant Influence ceases OR When severe long-term restrictions commence

Mechanics of Equity Accounting

I must adjust As results for differences in accounting policies

Accounting Policies

Use most recently available financial statements of A (usually same year end as I)

Accounting Dates

Be consistent from period to period Where year-ends are different, make adjustments for significant events/transactions

Disclosure
Accounting Policies List of significant Associate holdings Balance Sheet presentation Income Statement presentation Contingencies Description of accounting policies used to account for associates (as required by IAS 1) Listing and description of significant associates, including the proportion of ownership interest and, if different, the proportion of voting power held. Investment in Associate (held as a long term asset)

Share of Associates earnings - separate item above Profit before Tax In accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets

Expected developments from the IASB

Definition of significant influence excludes joint control Investments held by venture capital entities apply IAS 39, unless it is a subsidiary Severe long-term restrictions significant influence unlikely to exist Temporary investment disposal within one year,not longer Reporting dates 3 months rule Uniform accounting policies no longer impracticability exemption Groups holding, but exclude holdings held by groups other associates or joint ventures Interest in associate includes goodwill and advances Display share of net after-tax profit separately show discontinuing operations New disclosures include summarised financial information

Scope of IAS 31
Covers accounting for interests in Joint Ventures, and the reporting of Joint Venture assets, liabilities, income and expenses in the financial statements of venturers and investors (This is regardless of the structure or form under which the joint venture activities take place.)

Definition of a Joint Venture

Joint Venture a contractual agreement whereby two or more parties undertake an economic activity that is subject to joint control.

Joint Control the contractually agreed sharing of control over an economic activity.

Control the power to govern the financial and operating policies of an economic entity so as to obtain benefits from it.

Contractual agreement

The contractual agreement Distinguishes interests with Joint Control from those where the investor has a significant influence Ensures no single venturer is in a position to exert universal control
Within IAS 31, activities with no contractual arrangement to establish joint control are not joint ventures

Different Forms of Joint Ventures

Jointly Controlled Entities Jointly Controlled Operations Jointly Controlled Assets

An entity is created and jointly controlled

Each venturer bears own costs and takes a share of the proceeds

An asset that is shared and jointly controlled

Separate legal entity formed

No legal entity formed

Accounting for Jointly Controlled entities

Jointly Controlled entities
Benchmark treatment Proportionate Consolidation

Combine assets, liabilities, income and expenses on a line by line basis.

Two methods

Alternative treatment Equity Method *

Include separate lines for each of assets, liabilities, income and expenses

* IAS 31 allows but does not recommend this method because proportionate consolidation better reflects the substance and economic reality of the Joint Venture

Expected developments from the IASB

No changes to IAS 31 expected. This is in relation to the ED of proposed Improvements to International Accounting Standards

SIC 12: Consolidation of Special Purpose Entities

Circumstances indicating that an entity controls an SPE The entity obtains benefits from the SPE s operation The entity has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, has delegated these decision-making powers. The entity holds the majority of the risks and access to majority of the benefits of the SPE The entity retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities. An SPE should be treated as a Subsidiary.

CONSOLIDATION METHODS

FULL CONSOLIDATION
Subsidiaries

PROPORTIONATE CONSOLIDATION
Joint Ventures

EQUITY METHOD
Associates

CONSOLIDATION METHODS

FULL CONSOLIDATION Minority Interest Calculation Investment / Equity Elimination and Goodwill Intra Group Balances and Profits

Mechanics of Consolidation
Inter-company Eliminations
The carrying amount of P's investment in S and Ps portion of pre-acquisition profits are eliminated Eliminate inter-company balances and transactions and resulting unrealised profits Unrealised losses from inter-company transactions should also be eliminated (unless cost cannot be recovered).

Consolidation Journal Entries

Balance Sheet net-off entries - Investments/ Equity - Trade Receivables /Trade Payables - Loans given /Borrowings - Bank deposits /Deposits - Reverse repurchase agreements/ Deposits Balance sheet unrealised profit eliminations - Inventories - Property, plant and equipment - Investments

Consolidation Journal Entries

Income Statement net-off entries - Sales / cost of sales - Other income /expense - Financial income /expense - Dividend income /distribution (*Be careful about the classifications of the intercompany balances in stand-alone financial statements of the subsidiaries!) Minority interest adjustment

Example 2

Minority interest
A minority interest arises when the parent company owns less than 100% of the subsidiary. The shares that are not owned by the parent company are said to be owned by the minority shareholders.
When the parent company does not own 100% of the subsidiary, the consolidation will be prepared in the following manner: * add all the subsidiary's net assets to those of the parent company, indicating the share of the subsidiary's net assets that are owned by the minority shareholders. This share is disclosed in the consolidated balance sheet as Minority Interest.

Minority interest
The minority interests computed on * Current year P/L * Retained Earnings and, * Capital, accordingly * All other items classified under equity (i.e.cumulative translation reserve, revaluation funds, available-for-sale reserve) Losses applicable to the minority in a consolidated subsidiary may exceed the minority interest in the subsidiarys equity. The excess, and any further losses applicable to the minority, are charged against the majority interest except to the extent that the minority has a binding obligation to, and is able to, make an additional investment to cover the losses. If the subsidiary subsequently reports profits, such profits are allocated to the majority interest until the minoritys share of losses previously absorbed by the majority has been recovered.

Example 3

CONSOLIDATION METHODS

PROPORTIONATE CONSOLIDATION
Full consolidation - minority interest

The application of Proportionate Consolidation

Consolidated balance sheet of the venturer includes its share of the assets that it controls jointly and its share of the liabilities for which it is jointly responsible.

Consolidated income statements of the venturer include its share of the income and expenses of the jointly controlled entity.

Example 4
i) Parent company P owns 50% of the shares of a jointly controlled entity J. Parent P has receivables from J regarding the consultancy services rendered in the amount of TL 9,000 million as of 31 December 2002.

ii)

Parent P earned TL 15,000 million consultancy fee from J during 2002.

What would be the consolidation entries?

Example 4
i) DR Accounts payables 4,500 4,500

CR Acoounts receivable

ii)

DR Other operating income

7,500
7,500

CR Operating expenses

CONSOLIDATION METHODS

EQUITY METHOD

SHAREHOLDERS EQUITY * SHARE PERCENTAGE =

INVESTMENT VALUE (Treatment of Dividend Income !)

Subsequent recording in the Balance Sheet

The carrying value of an Associate investment increases/ decreases by the investors % of profit/loss each Goodwill is shown as an element of cost and is subsequently amortised over its useful life Any distribution of dividends will reduce the carrying value of the investment .

Equity Method

Value of Investment % Investment Profit made by associate Share of profit Carrying Value

200 20% 400 100 300

Income Statement
Investors share of Associates profit before tax is disclosed on one line Investors share of Associates tax and extraordinary items are added to the corresponding lines

Example 5

TREATMENT FOR FOREIGN ENTITIES

Scope of IAS 21
Should be applied: In accounting for transactions in foreign currencies; and In translating the financial statements of foreign operations that are included in the financial statements of the entity by consolidation, proportionate consolidation or by the equity method.

Classification
Integral to the operations of the reporting entity

Foreign entity

Extension of parents operations

Autonomous

Indicators of status of foreign entities

Activities carried out with autonomy

Sales in other than reporting currency

Activities financed from own operations or local borrowings

Foreign entity

Low volume of transactions with parent

Costs settled in local currency

Parent cash flows insulated from those of foreign operation

Integral operations: Translation

Income statement - average rate
Balance sheet Non monetary - historical rates Monetary closing rates FX differences in income statement

Foreign entity: Translation

Income statement - average rate
Balance sheet - closing rate FX differences - classify in equity Disposals - release FX differences to P&L

Other key points

Income and expense items of a foreign entity reports in the currency of a hyperinflationary economy should be translated at the closing rates. Income and expense items of a foreign entity translated at exchange rates at the dates of transactions should be restated to purchasing power at the closing date.

Expected developments from the IASB

Functional currency currency of the primary economic environment in which entity operates Presentation currency can be functional currency or another currency - SIC 30 Monetary / non-monetary items clarified Impairment of foreign currency non-monetary asset clarified Exchange component of revaluation gain / loss (IAS 16) also goes to equity Net investment in foreign entity moved to IAS 39 Use of presentation currency other than functional currency apply IAS 21 principles used for foreign entity Convenience translation must designate as supplementary information disclose method