UNIT 3

1. Concept of Group & purpose of Consolidated Financial Statements 
2.  Holding company
3. subsidiary company
4. Computation of goodwill
5. minority interest
6. pre-acquisition and post-acquisition profits
7. inter-company transactions
8. treatment of unrealized profits

1Q)Concept of Group & purpose of Consolidated Financial Statements 

      It is an era of business growth many organizations are growing into large corporations by the process of acquisition, mergers, gaining control by one company over the other company, restructuring, etc. Acquisition & mergers ultimately lead to cost reduction / controlling the market / sharing the material supplies /product diversification / availing tax benefits. Whatever may be, the ultimate result is a large-scale corporation. The formation of a holding company is the most popular device for achieving these objectives.

             Many a time, a company expands by keeping intact its separate identity. In this situation, a company (holding) gains control over the other company (subsidiary). This significant control is exercised by one company over the other either by purchasing a specified number of shares / exercising control over the board of directors / or voting power of that company.  A unit of companies connected in these ways is collectively called a group of companies. Consolidated statements are specifically meant to present the state of affairs of the group as a whole treating the group as a single entity. 

• Parent means a company that has one / more subsidiaries. 
• A subsidiary is an enterprise that is controlled by another enterprise. 
• Group means parent & all its subsidiaries. 
• Consolidated financial statements - are the financial statements of a group presented as those of a single enterprise. 

Accounting standard 21- consolidated financial statements issued by the council of the ICAI. It comes into effect in respect of accounting periods commencing on/after 1-04-2001. An enterprise that presents consolidated financial statements should prepare & present these statements under this standard. 

    

  As per AS 21, consolidated financial statements normally include :

1. Consolidated balance sheet 

2. Consolidated statements of profit & loss account 

3. Consolidated cash flow statements. 

Purpose of preparing the consolidated financial statements :

        Consolidated financial statements are the financial statements of a group presented as those of a single enterprise, where a group refers to a parent & all its subsidiaries. Parent company needs to inform the users about the financial position and results of operations not only of their enterprise itself but also of the group as a whole. 

Objective : 

The objective of this statement is to lay down principles & procedures for the presentation and preparation of consolidated financial statements. These are prepared by the holding company (parent)  to provide financial information about the economic activities of its group. These statements are intended to present financial information about a parent and its subsidiary as a single entity. 

Scope :

1. This statement should be applied in the preparation & presentation of consolidated financial statements for a  group of enterprises under the control of a parent. 

2. This statement should also be applied in accounting for investments in the subsidiary in the separate financial statements of a parent. 

3. A parent that presents cash flow statements should consolidate all subsidiaries, domestic as well as foreign. 

Consolidation procedure:

1. In preparing consolidated financial statements, the financial statements of the parent and its subsidiary should be combined on a line-by-line basis by adding together items of assets, liabilities, income& expenses. 

2. Intra-group balances & intra-group transactions and resulting unrealized profits should be eliminated, in full. Unrealized losses resulting from the intragroup transaction should also be eliminated unless the cost cannot be recovered. 

3. Consolidated financial statements should be prepared using uniform accounting policies for like transactions and other events in similar circumstances. If it is not practicable to use uniform accounting policies in preparing the consolidated financial statements, that fact should be disclosed together with the proportions of the items in the consolidated financial statements to which the different accounting policies have been applied. 

4. An investment in an enterprise should be accounted for per accounting standard (AS) 13:Accounting for investments , from the date that the enterprise ceases to be a subsidiary & does not become an associate. 

5. Minority interest should be presented in the consolidated balance sheet separately from liabilities & the equity of the parent's shareholders. minority interest in the income of the group should also be separately presented. 

Disclosure :

1. In consolidated financial statements a list of all subsidiaries including the name, country of incorporation/residence, proportion of ownership interest & if different proportion of voting power held. 

2. In consolidated financial statements, where applicable :

* The nature of the relationship between the parent and a subsidiary, if the parent does not own, directly / indirectly through subsidiaries, more than one-half of the voting power of the subsidiary. 

* The effect of the acquisition & disposal of the subsidiary on the financial position at the reporting date, the results for the reporting period & the corresponding amounts for the proceeding period &

* The names of the subsidiaries of which reporting dates are different from that of the parent and the differences in reporting dates. 

2Q) . Holding Company: The holding company is a company that acquires either the whole/majority of the shares of one / more companies with a view to securing the controlling interest in such companies. as per the Companies Act no company can be called a holding company by its constitution to be called a holding company it must have a subsidiary. in the case of amalgamation/ absorption, at least one company goes into liquidation but under the holding company concept both companies retain their entities and they can do their business in their own names.

  holding companies are able to nominate the majority of the directors of the subsidiary company. the company gets such right when it purchases more than 50% shares of another company. so, the holding company is one which controls one/ more other companies either by means of holding more than 50% shares in that company/ companies / by having the power to appoint the whole/majority of the director of those companies. A company controlled by a holding company is termed a subsidiary company and a company controlled by the subsidiary company is termed a sub-subsidiary company of the principal holding company.

Presentation of accounts:

In India, it is not compulsory for the holding company to make a consolidated financial statement. according to the Indian companies act the following information regarding the subsidiary companies is to be disclosed in the published accounts of a holding company.

•  a copy of the balance sheet of subsidiary
• a copy of its profit and loss a/c
• a copy of the report of its board of directors
• a copy of the report of its auditors
• the statement of holding companies interest in the subsidiary company and the profits of the subsidiary

Advantages:

•  It is very easy to form a holding company because we simply have to purchase the controlling interest of other companies
• each member of the group has to prepare separate a/cs and such the results of operations and the financial position of each constituent part can be easily ascertained.
• it is a very flexible form of combination as when a company wants to shift its control over the other companies, it has simply sold the shares of that company.
• separate entities of subsidiaries are maintained, their losses may be carried forward for IT purposes
• the failure of a product of a subsidiary company will not affect the holding company
• a holding company  is not required to bear any  loss of the subsidiary company

Dis advantages:

•  intercompany transactions are often entered at unduly low prices in order to suit the holding company
• minority shareholders' interests may not be properly protected
• there is a possibility of fraudulent manipulation of accounts.
• the accounts of various companies may be made upon different dates to manipulate the profit/ financial position of group companies
• the shareholders in the holding company may not be aware of the true financial position of the subsidiary company

 

3Q) Subsidiary company:

According to Section 4 of the Companies Act 1956, a company shall be deemed to be a subsidiary company of another company if and only if:

• that the other company controls the composition of its board of directors
• when the other company holds more than half of the nominal value of its equity share capital
• when it is a subsidiary of any company that itself is a subsidiary of another company, the original holding company is also a holding company of that other subsidiary company.

wholly owned and partly owned subsidiaries:

    A wholly owned subsidiary company is one in which all the shares with voting rights of 100% are owned by the holding company. whereas in a partly-owned subsidiary, only the majority of shares are owned by the holding company. In a wholly-owned subsidiary, there is no minority interest because all the shares with voting rights are held by the holding company. on the other, in a partly owned subsidiary company, there is a minority interest because <50% of shares with voting rights are held by outsiders other than the holding company.

4Q)GOODWILL/ COST CONTROL:

If the holding company purchases the shares of the subsidiary company at a  price that is more than the paid-up value of the shares, the excess amount paid represents payment for goodwill or the cost of acquiring control of the subsidiary company if there exists no reserve/ profit/ loss balance in the subsidiary company on the date of acquisition of shares of the subsidiary company. If the shares are purchased at a price that is less than the paid-up value of shares, the less amount paid represents capital reserve. Thus, if 9000 shares @10 each are purchased at Rs.100000 the excess amount paid Rs.10000(100000-90000) is goodwill and will be shown on the assets side of the consolidated balance sheet as goodwill. on the other hand, if the price paid for 9000 shares@10 each is Rs.80000 the less amount of Rs. 10000 (80000-90000) is capital reserve shown on the liabilities side of the consolidated balance sheet as capital reserve.

It will be calculated as follows:

                    Particulars                                                                                              Amount

cost of investment in shares of subsidiary company                                                         xxx

less: Paidup value of shares                                                                                                xx

         Share of capital profit of holding company                                                                xx

                                                                                                                                        ------------

                                                                                                                                            xxx

                                                                                                                                         -------------

5Q) MINORITY INTEREST:

 When some of the shares of the subsidiary company are held by outsiders, their interest known as a minority interest in the subsidiary company is calculated and shown on the liabilities side of the consolidated balance sheet of the holding company. the share of the outsiders in the subsidiary company is called minority interest because they are having <50% of the shares of the subsidiary company. the minority interest is calculated as follows:

        Particulars                                                                       Amount

Paid-up value of shares held by outsiders                                      xxx

Add: share of capital profit                                                             xx

        share of revenue profit                                                            xx

                                                                                                      ---------

                                                                                                         xxx

                                                                                                      ---------

if preference shares are held by outsiders the paid-up value of such shares together with dividends there thereon is also added to the value of minority interest/ shown separately. proportionate share of the subsidiary companies' profit and reserves belonging to the outsiders is calculated keeping in view the value of equity shares held by them and the value of the preference shares in not considered because profits and reserves belong to equity shareholders and not preference shareholders.

6Q) PRE-ACQUISITION, AND POST-ACQUISITION PROFIT:

Profits of the subsidiary company must be allocated between the pre-acquisition and post-acquisition periods. All profits of the subsidiary company on the date of acquisition of shares are shown as capital profit and profits earned subsequent to the date of purchase are treated as revenue profits.

 If shares are acquired in the course of a financial year, all reserves and profit & loss are balanced at the beginning of the year and will be treated as capital profits, but in addition, current year profits up to date of acquisition will also be treated as capital profit

     

           Similarly, the losses of the subsidiary company up to the date of acquisition are treated as capital loss & subsequent to acquisition as revenue loss.

        Any increase in the value of fixed assets of the subsidiary company whether before/ after the acquisition will also be treated as capital profit and if there is a reduction in the value of fixed assets as of the date of acquisition, it should be treated as capital loss and deducted from capital profits. But if the fall in the value of assets occurs after the date of acquisition the loss should be treated as an ordinary loss.

both capital and revenue profits have to be apportioned between the holding company and minority shareholders in proportion to the shares held by them. holding company's share of capital profit should be deducted from cost control/goodwill and the share of revenue profit should be added to the profits of the holding company. minority shareholders' share of capital and revenue profits should be included in their interest.

 

 if fictitious assets like preliminary expenses are given in the balance sheet of the subsidiary company then they should be deducted from capital profits before distributing the same among the holding company and minorities.

7Q) Inter-company transactions:

In preparing a consolidated balance sheet, common transactions appearing in both the balance sheets of the holding company and the subsidiary company should be eliminated. such transactions may be:

• Goods sold on credit by the holding company to the subsidiary company/vice-versa will appear as debtors in the balance sheet of the company selling goods and creditors in the balance sheet of the company purchasing goods.  
• bills drawn by one company and accepted by the other company are eliminated while preparing a consolidated balance sheet but bills discounts and endorsed will continue to appear as a liability because the company, which has accepted such bills, will have to make the payment to outsiders on the due date.
• loans advanced by the holding company to the subsidiary company/ vice-versa appear as an asset in the balance sheet of the company which gives such loans and as a liability in the balance sheet of the company that takes these loans.
• debentures issued by one company and held by the other company should also be eliminated from both sides- from debentures on the liability side and investment on the assets side

8Q) Treatment of unrealized profits:

If the goods sold at a profit by the subsidiary company to the holding company/ by the holding company to the subsidiary company remain unsold at the close of the financial year the profit charged by the company on unsold goods remains unrealized. In such a case it is not proper to credit the profit and loss a/c with such unrealized profit. so, a stock reserve is created and profit is reduced by the unrealized profit. such unrealized profit has to be eliminated from the consolidated balance sheet in the following manner:

• The unrealized profit should be deducted from the current revenue profit of the company which sold the goods
•       again, the same should be deducted from the value of the stock-in-trade of the company concerned.
• EXAMPLE: H LTD purchased from S LTD goods of the value of Rs.50000 on which S LTD has charged a profit of 25% on cost & goods worth Rs.20000 remained unsold at the end of the financial year. unrealized profit, in this case, will be Rs. 4000(i.e. 25/125  x 20000) while preparing a consolidated balance sheet, a stock reserve of Rs.4000 will be deducted from stock on the assets side and the balance of profit and loss a/c of H LTD will be reduced by Rs.4000 on the liabilities side.