Enquiry:

The Technical guidance is requested from the Committee on consolidation of accounts by a listed company (hereinafter referred to as LC) which has recently acquired another listed company (hereinafter referred to as ALC) operating in financial sector – a bank. The LC has acquired 43.15% shares of ALC directly and 10.94% shares through its another subsidiary. Year 2013 will be the first year after acquisition of ALC that the holding company will be preparing its F.S. Following are the issues faced for consolidation.

1. LC holds 43.15% shares of ALC directly and 10.94% indirectly through its subsidiary.
2. In terms of section 3(2) of the Companies Ordinance, 1984 (CO-1984) the LC has become a holding Co. of ALC.
3. Owing to the application of section 3 of CO-1984, presentation of consolidated financial statements of the group as a single entity in terms of section 237 of CO-1984, are also required to be made by LC, in addition to the standalone financial statements. Such consolidated financial statements are to be prepared in accordance with the disclosure requirements of the Fourth Schedule of CO-1984 and International Accounting Standards (IAS) notified under section 234 (3) of CO-1984.
4. The ALC, being a company in financial sector is regulated by SBP while the holding Co. (LC) is regulated by SECP.
5. As directed by SBP, IAS 39 & 40 are not applicable to ALC while as mandated by SECP, all IAS/IFRS as notified by it are applicable on companies regulated by SECP. Such IAS/IFRS include IAS 30 & 40.
6. IAS 27 on consolidated and separate financial statements requires that the consolidated financial statements shall be prepared using uniform accounting policies. In other words, additional financial statements of the subsidiary (ALC) are required to be prepared using policies and bases as that of LC in order to facilitate consolidation.

Difficulties in complying with the reporting requirements:

1.    Nature of the businesses of LC and ALC:

LC and the ALC are both public listed companies, however, their nature of business and economic sectors are very different. The statutory, regulatory and the reporting requirements of the two companies are poles apart, on individual basis. The LC is regulated by SECP under C.O 1984, while ALC is regulated by SBP under BCO 1962. All IFRS notified by the SECP are applicable on LC while ALC has been exempted by the SBP from application of IFRS 39 & 40.

2.    LC ownership does not constitute control in terms of IFRS 10: IFRS 10 which is effective from accounting periods starting 01 January, 2013, has not yet been adopted by ICAP/SECP. Once adopted, this will replace IAS 27. As required by IFRS 10, an entity that is a parent shall present consolidated F/S and the entity shall determine whether or not it is a parent by assessing whether it controls the investee (para 5 of IFRS 10). An entity controls an investee when it is exposed or has the rights to variable returns from its involvement in the investee. (para 6 of IFRS 10).Thus an investor controls an investee if and only if investor has all the following;

1.    power over the investee,
2.    exposure, or rights, to variable returns from its involvement with the investee; and,
3.    the ability to use its power over the investee to affect the amount of the investor’s returns.  (para 7)

While the LC holds 43.15% of the Bank’s shares, however, it does not have “control” as defined by IFRS 10. It does not fulfil any of the following conditions of IFRS 10 para 7, necessary to constitute a “control”.
•    Power over the investee
•    Exposure, or rights, to variable returns from its involvement with the investee; and
•    The ability to use its power over the investee to affect the amount of the investor’s returns.

We have been informed by LC that it also does not have control over the appointment of Board members and influencing the decision making processes, which, in this respect, rests with the parent organisation of LC. This fact is demonstrable from the composition of the board of directors of the ALC which has only 2 directors nominated by LC.

3.    Value to the users of the financial statements

The Framework for the preparation and presentation of financial statements (the Framework) issued by the International Accounting Standard Committee (IASC), prescribes that one of the key objectives of Financial Statements is its usefulness to the wide range of users in making economic decisions. Balance sheet size of the LC is approximately Rs. 65 billion while that of ALC, Rs. 340 billion (approximately 5 times of the holding Co.). As on 30 June 2013, the LC has posted a PBT of Rs. 6.6 billion while ALC has posted a loss of 6.8 billion. As mentioned above, the consolidated financial position and results of operations may differ significantly compared to the standalone results of the ALC and LC. In other words, the users of consolidated Financial Statements would be getting two drastically different set of financial information of the ALC and LC, which would be counterproductive and against the objectives of issuing the Financial Statements and the Framework for the preparation and presentation of FS. International Accounting Standard 1 – Presentation of Financial Statements, also allows that in the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement.

As has already been discussed above, the regulatory and reporting requirements of the two companies are significantly different along with business dynamics. As a result:

• Balance sheet size of LC is around Rs.65 billion whereas total assets of the ALC hovers around Rs.340 billion – approximately 5 times of LC.
• Components of balance sheet and income statements are completely unrelated and highly different to each other.
• LC statutory reporting format is on the basis of current and non-current assets and liabilities, whereas such bifurcations are not required for ALC.

4.    IAS 27 on consolidated and separate financial statements requires that the consolidated financial statements shall be prepared using uniform accounting policies. In other words, additional financial statements of the subsidiary (ALC) are required to be prepared using policies and bases as that of holding company in order to facilitate consolidation. For the purpose of consolidated financial statements, ALC will be required to prepare additional financial statements as per the policies of LC, which would require considerable amount of additional resources, costs, and time. However, even if the ALC prepares specific purpose financial statements;

i.    the accuracy of these FS may still be questionable in view of the fact that SBP guidelines in respect of certain intricate matters would not be available;

ii.    these FS are subject to the review of the auditors including all interim FS of ALC. The adequacy of skills and expertise for conducting audit of such FS is also not available in Pakistan;

iii.    these FS would significantly differ from the financial statements prepared and disseminated by the ALC to the users of FS on a standalone basis.

iv.    significant differences between the accounting and reporting frameworks of the BCO 1962 and the CO 1984 including the following, which requires an additional set of financial statements above the already prepared standalone and consolidated financial statements by ALC:

a.    recognition of interest income on impaired assets (Non-Performing Loans)
b.    Accounting and presentation of Investments
c.    impairment of advances
d.    investment properties
e.    ALC’’s segment reporting disclosures (including commercial banking, retail banking, asset management, brokerage business etc.)
f.    ALC requirement to consolidate its more than 250 branches in addition to subsidiaries, resulting in holding of BOD meetings in the month of August, in comparison to LC’s Board meetings in the month of July.
g.    Uniform Accounting Policies – Aligned with FFC

v.    revaluation of ALC’s Fixed and other assets for determination of Goodwill.

Guidance Sought from the ICAP

In view of the factual position narrated above and provisions of relevant IFRS/IAS/IFRIC (specifically in view of pending adoption of IFRS 10 in Pakistan), is it still technically essential & practically possible for the LC to consolidate ALC financial statements?

Opinion:

Your attention is drawn to the following paragraphs of IAS 27 ‘Consolidated and Separate
Financial Statements’ and the requirements of section 237 of the Companies Ordinance 1984, which are self-explanatory: (underlining is ours)

9     A parent, other than a parent described in paragraph 10, shall present consolidated financial statements in which it consolidates its investments in subsidiaries in accordance with this Standard.

10     A parent need not present consolidated financial statements if and only if:

(a) the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements;

(b) the parent’s debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets);

(c) the parent did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market; and

(d) the ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with International Financial Reporting Standards.

237.     Consolidated financial statements. (1) There shall be attached to the financial
statements of a holding company having a subsidiary or subsidiaries, at the end of the financial year at which the holding company’s financial statements are made out, consolidated financial statements of the group presented as those of a single enterprise and such consolidated financial statements shall comply with the disclosure requirements of the Fourth schedule and International Accounting Standards notified under sub-section (3) of section 234.

The Committee would recommend that the Company take guidance from the above paragraphs while preparing consolidated financial statements.

(November 08, 2013)