Consolidation goes “hand in hand” with any foreign business.
But what is it?
Many people refer to consolidation when they speak about their share in other business in general.
However, we need to differentiate between the individual types of investments in other businesses, because every type of the investment is accounted for in its own way.
What Shall We Do?
First, you need to determine what type of investment you’re dealing with.
Then, you need to look in the appropriate IFRS standard and apply the appropriate rules.
In today’s article and video, I’d like to outline the basic types of investments, their accounting methods and the IFRS standards you should be looking at.
As the consolidation and group accounts belong to the most popular topics examined in any accounting exam, this is the first article in my “consolidation series”, which will be followed by IFRS summaries and on top of that, I’ll add full consolidation package of lectures and case studies into my IFRS Kit.
IFRS Standards Dealing with Group Accounts
There are 6 IFRS standards dealing with group accounts:
1. IAS 27 Separate Financial Statements
This standard prescribes how the investor shall present its investments in the individual or separate (non-consolidated) financial statements.
Before 2013, IAS 27 covered also consolidated financial statements, but this part has been superseded and starting 1 January 2013, you should look to IFRS 10 for the rules about consolidated financial statements.
2. IAS 28 Investments in Associates
IAS 28 prescribes the accounting treatment of associates, or the entities in which the investor has significant influence (but not control or joint control).
3. IFRS 3 Business Combinations
IFRS 3 outlines the accounting when the investor obtains a control over its investment.
People are often confused because both IFRS 3 and IFRS 10 deal with this situation, but each of these standards deals with its own aspects of the same thing.
IFRS 3 tells us what the business combination is, how to account for it at the recognition (but not when you perform consolidation afterwards – then it’s IFRS 10), how to measure goodwill, non-controlling interest and assets and liabilities acquired.
4. IFRS 10 Consolidated Financial Statements
This is the second standard dealing with the situation when the investor obtains a control over its investment.
As opposed to IFRS 3 mentioned above, IFRS 10 defines the control and gives a guidance to identify whether there is a control or not.
Then it also prescribes the consolidation procedures for preparing consolidated financial statements.
5. IFRS 11 Joint Arrangements
IFRS 11 deals with the third type of investment – joint arrangement, which could be a joint operation or joint venture. In both cases, investor obtains joint control over some business with some other investor.
Before 2013, IAS 28 included the rules for joint arrangements, but now, we should look to IFRS 11.
6. IFRS 12 Disclosure of Interests in Other Entities
IFRS 12 relates to all types of interests in other entities: subsidiaries, associates, joint arrangements and unconsolidated structured entities.
It requires disclosures of various kind of information about these interests.
How to Account for Your Investment
As I’ve already mentioned above, you should first determine WHAT TYPE of investment you deal with and based on the type, apply specified accounting treatment.
There are the 4 basic types of investments:
IFRS 10 defines a subsidiary as “an entity controlled by another entity”.
The basic indicator of having a control over subsidiary is the size of your share in it. If you own more than 50% of investment’s shares, then it indicates you control it.
However, that’s not always the truth and sometimes, investor does NOT have a control even if it owns more than 50% of shares. The opposite may be true: investor can have a control despite the share lower than 50%.
If there is a control, then investor must account for such an investment using the acquisition method and apply full consolidation procedures when making consolidated financial statements.
IAS 28 defines an associate as “an entity over which an investor has significant influence and which is neither a subsidiary nor an interest in joint venture”.
Here, the basic indicator of significant influence is the investors share between 20% and 50%, but similarly as with subsidiaries and control, there are situations where significant influence might or might not be demonstrated regardless the size of ownership.
If there’s a significant influence, then investor must account for such an investment using the equity method.
3. Joint Arrangements
IFRS 11 defines joint arrangement as “arrangement of which 2 or more parties have joint control”.
It does not make any sense to quantify the “share” here, because it should be equal for all the parties. So if there are 2 parties of arrangement, each party has 50% share. If there are 3 parties, each party has 33.3% share – you get the idea.
Instead, parties need to exercise joint control over the arrangement. It means that important decisions require unanimous consent of all parties of the arrangement and no single party can decide independently.
IFRS 11 requires accounting for joint arrangement based on its specific type:
- If parties established joint venture, then each party accounts for its investment using the equity method in line with IAS 28, and
- If parties established joint operation, then each party accounts for its own assets, liabilities, expenses, revenues and its share on all items incurred jointly.
4. Other Investments
This was just a very quick and short introduction to the world of group accounts and consolidation and details are in the other articles that I recommend you to read:
- IAS 28 Investments in Associates and Joint Ventures
- IFRS 3 Business Combinations
- IFRS 10 Consolidated Financial Statements
- IFRS 11 Joint Arrangements
- Example: How to consolidate
Full consolidation learning package is included in my IFRS Kit so you can have a great resource and support for your exams
Meanwhile, you can watch the intro to consolidation here: