IAS 27 SEPARATE FINANCIAL STATEMENTS

1. Consolidation of Financial Statements

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.

  • LC holds 43.15% shares of ALC directly and 10.94% indirectly through its subsidiary.
  • In terms of section 3(2) of the Companies Ordinance, 1984 (CO-1984) the LC has become a holding Co. of ALC.
  • 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.
  • The ALC, being a company in financial sector is regulated by SBP while the holding Co. (LC) is regulated by SECP
  • 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
  • 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:

  • 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.

  • 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:

  • 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. (para 7)

While the FFCL 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.

  • 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.
  • 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;
  • 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;
  • 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;
  • these FS would significantly differ from the financial statements prepared and disseminated by the ALC to the users of FS on a standalone basis.
  • 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:
    • recognition of interest income on impaired assets (Non-Performing Loans)
    • Accounting and presentation of Investments
    • impairment of advances
    • investment properties
    • ALC’’s segment reporting disclosures (including commercial banking, retail banking, asset management, brokerage business etc.)
    • 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.
    • Uniform Accounting Policies – Aligned with FFC
  • 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)

2.     Presentation of non-controlling interest in consolidated Financial Statements

Enquiry:

Preparation of consolidated financial Statements of a family owned Holding and Subsidiary company is in progress. Both the companies are managed/owned by the same family however 40% shares of subsidiary are directly owned by the family whereas 60% owned by the Holding company.

What should be the presentation/accounting treatment in consolidated financial statements of Non Controlling interest artificially arise due to holding of subsidiary shares in individual capacity by the shareholders.

Opinion:      

The Committee would like to draw your attention to the definitions of ‘Non-controlling interest ‘and ‘Parent’ given in IAS 27 ‘Consolidated and Separate Financial Statements’:

 Non-controlling interest is the equity in a subsidiary not attributable, directly or indirectly, to a parent.

  A parent is an entity that has one or more subsidiaries.

The Committee is of the view that it is evident from the above that direct shareholding by individual family members in the subsidiary company will not be converted into controlling interest even though the same family members are shareholders of the holding company.

(March 1, 2012)

3.  Consolidation of the Financial Statements of Software House

Enquiry:

This is with reference to our telephonic conversation this morning, I would be grateful if you can advice me on the following:

We are running a brokerage house as a Public Un-Listed Company apart from this as of June 30, 2003 we had the following subsidiaries:

1) Software House              Private Limited Company    Holding 99.98%
2) Marketing Company     Private Limited Company    Holding 85.00%
3) Travel Agency                Private Limited Company    Holding 55.00%

Software House

We had written off the entire investment in software house from our (parent company) books at June 30, 2003 and subsequently in April 2004 this company was liquidated as well. So this company has no existence as on June 30, 2004.

Now the question is should we consolidate the financial statements of software house in our books?

Marketing Company

This company was dormant for a long time and in March 2004 this company was also liquidated. We have received the amount of surplus distributed by the subsidiary company to its shareholders against which we have set off our investment. So this company is also not in existence as on June 30, 2004.

Now the question is should we consolidate the financial statements of marketing company in our books?

Travel Agency

This company issued further shares on July 22, 2003 and we had not exercised the rights because of this reason our shareholding diluted in such a manner that this company became an Associate.  From July 22, 2003 till to date (June 30, 2004) we are maintaining the same status with this company.

Now the question is should we consolidate the financial statements of travel agency in our books?

Note the Accounting Years of all companies are July to June.

Opinion:

The Committee deliberated your enquiry in detail and is of the view that once the parent /holding company ceases to have control of the subsidiary or subsidiaries the parent company should not consider such subsidiary or subsidiaries in preparation of consolidated balance sheet.

However the said parent company, even if it does not have any other subsidiary, would be required to prepare and issue consolidated financial statements provided the company had prepared and issued consolidated financial statements in the immediate preceding year. The only reason for this is to make the readers aware of the previous year’s figures and to help them compare the financial position of current year with the previous year. In this regard your attention is drawn toward the following paragraph of IASB Framework.

42.  Because users wish to compare the financial position, performance and changes in the financial position of an enterprise over time, it is important that the financial statements show corresponding information of the preceding periods.

Here the Committee would like to point out that consolidated balance sheet included in the consolidated financial statements and the parent company’s own balance sheet will remain the same because parent company is no more holding any subsidiary.

With regard to the preparation of consolidated income statement the Committee would like to draw your attention towards the following paragraph of IAS 27 which is self explanatory:

23      The results of operations of a subsidiary are included in the consolidated financial statements as from the date of acquisition, which is the date on which control of the acquired subsidiary is effectively transferred to the buyer, in accordance with IAS 22 Business Combinations. The results of operations of a subsidiary disposed of are included in the consolidated income statement until the date of disposal which is the date on which the parent ceases to have control of the subsidiary. The difference between the proceeds from the disposal of the subsidiary and the carrying amount of its assets less liabilities as of the date of disposal is recognized in the consolidated income statement as the profit or loss on the disposal of the subsidiary. In order to ensure the comparability of the financial statements from one accounting period to the next, supplementary information is often provided about the effect of the acquisition and disposal of subsidiaries on the financial position at the reporting date and the results for the reporting period and on the corresponding amounts for the preceding period.

(September 11, 2004)

4.          Consolidation of Financial Statements

Enquiry:       

The Securities and Exchange Commission of Pakistan (SECP) has directed us to seek advice from the Institute regarding consolidation of financial statements. Please find enclosed the letter received from SECP.

BRIEF BACKGROUND

ABC Fund Limited (the Fund) is a venture fund. The Fund was incorporated on July 16, 2003 and is managed by XYZ Ventures Limited (The Venturers).

VENTURE CAPITAL INVESTMENT – AN OVERVIEW

The main idea of venture capital as by definition – investment in risky projects with the anticipation of getting higher returns. These funds are invested in industries, which are unable to access the funds through the conventional sources such as banks and financial institutions. Such risky enterprises generally do not have any major collateral to offer as security, hence banks and financial institutions are averse to funding them. Venture capital funding may be by way of investment in the equity of the new enterprise or a combination of debt and equity, though equity is the most preferred route.

Most of the ventures financed through this route are especially in the “industries” like infotech, electronics, biotechnology, and communication or in short can be said to be ICE industries. Venture capitalists apart from offering money take active participation in management of the company. They evaluate and monitor the project on a continuous basis. The returns on the investment by the venture capitalist generally come in the form of selling the stocks when they get listed on the stock exchange or by a timely sale of his stake in the company. Venture capitalists assess several projects and invest only in a handful after careful scrutiny of the management and marketability of the project. Exit is preferably process of getting out of the venture through a public issue and listing on stock exchanges.

OUR STRUCTURE

Rule 25(1) (d) of the Non-Banking Finance Companies (Establishment and Regulation) Rules 2003 (NBFC Rules) requires every venture fund to enter into a contract, in writing, with a NBFC duly licensed by the SECP to operate as a venture capital company for managing its entire business. The Fund has entered into a management contract with the Venturers for managing its entire business. Following are the key powers delegated to the Venturers under this management contract:

    • to make investments of funds available with the Fund in venture projects as contemplated and defined by the Rules from time to time;
    • to pay for acquisition of shares, securities or such properties, rights and privileges as are or may be acquired for monetary consideration either wholly or partly in cash or in shares or by way of exchange or other securities of the Fund;
    • to secure fulfillment of any and all contracts or agreements entered into by the Fund in respect of any venture projects, shares, securities or of any property, whether movable or immovable, and in force and realize all claims or demands of the Fund;
    • to appoint advisers, managers, contractors, officers, clerks, agents and servants for permanent, temporary or special services as the Management Company may from time to time think fit and to determine their powers and duties and fix their salaries, emoluments or remuneration and to require security in such instance and of any amount as may be thought fit and to remove, suspend or terminate contracts with them;
    • to appoint any person or persons, whether incorporated or not to accept and to hold on trust or under any specific arrangements for the Fund any property belonging to the Fund or in which it is interested or for any other purpose and to execute and do all such acts and deeds and to provide for the remuneration of such Trustee or Trustees and to revoke such trust or arrangements;
    • to institute, commence, conduct, defend, compound or abandon any legal proceedings by or against the Fund or its officer or officers or otherwise concerning the affair or affairs of the Fund and also to compound and allow time for payment or satisfaction of any claim or demand by or against the Fund and to sign, swear and verify pleadings, give evidence, pay court fees and legal costs and to appoint advocates for any or all for the said purposes, and to revoke their powers or appoint other advocates in their place, as also appoint chartered accountants, income tax practitioners or lawyers, in general;
    • to refer any claim or demand by or against the Fund to arbitration and observe and perform the awards;
    •  to make, give receipts, releases and such other discharges for money payable to and received and for the claims and demand of the Fund;
    • to determine who shall be entitled to sign on behalf of the Fund, bills, notes, receipts, acceptance, endorsement, cheques, releases, contracts and documents in the name of the Fund and deal with the funds and assets of the Fund;
    • to provide for the management of the affairs of the Fund, in or outside Karachi and in particular to appoint any person to be attorneys, brokers, commercial or other agents of the Fund with such powers, including powers to sub-delegate and upon such terms as the Management Company may think fit;
    • to invest and deal with any money of the Fund not immediately required for the purposes thereof, in such manner and upon such securities as may be thought fit from time to time and to vary or release such investments;
    • to open and operate bank accounts in the name of the Fund with any bank, to sign and execute all and several documents, instruments and instructions  pertaining to all and every such account, including cheques;
    • to enter into all such negotiations, contracts and to rescind and vary all suchacts, deeds and things in the name and on behalf of the Fund as the  Management Company may consider expedient for or in relation to the matters aforesaid or otherwise for the purpose of the Fund;

The Venturers had invested in equity of four venture projects on behalf of the Fund where the Fund holds majority of the voting rights (see picture 1). Section 237 of the Companies Ordinance, 1984 requires the holding companies to attach consolidated financial statements of the group presented as those of a single enterprise with the financial statements of the company.

Picture 1

QUERY

Whether the Fund’s consolidated financial statements present a meaningful picture to its investors if definition of subsidiary given in Section 3 of the Company Ordinance is kept set-aside.

We believe that following are the reasons for preparing single company financial statements instead of consolidated financial statements:

  • Voting rights

Power over the voting rights in these venture projects are delegated to the Venturers being the management company of the Fund. Thus, the Fund is not able to participate in the affairs of the venture projects.

  • Representation on the board of directors

Under NBFC Rule 25 (2), the board of the venture capital fund should not have a director, who is on the board of any venture project being financed by the Fund. Therefore, the Fund is not directly or indirectly involved or participating in the financial and operating policies of these venture projects.

The Venturers by virtue of their management contracts have the power to nominate directors on the board and manage the affairs of these venture projects. This indicates that the ability to control the financial and operating policies of these venture projects is not there.

  • Fair presentation

A typical venture project burns it entire capital before it generates any cash flows and for investors it will be a long time before they actually receive any cash flow from these venture projects. The real cash flow which the Fund investors are looking for will come through capital gains arising from strategic sale or public offer of these venture projects. Therefore, from an investor point of view the real value lies in valuation of these investments on portfolio basis. Consolidation of these venture projects would give a misleading picture because the nature and dynamic of every venture project is different.

  • Intention to sale

Similar to any other venture capital fund in the world, the Fund intends to obtain benefit from venture projects through strategic sale i.e. to earn capital gain. Therefore, the consolidated results of these venture projects will not have any real investor value.

  • By-pass vehicle

The Fund is used as a by-pass vehicle where the sponsors of the Fund have pooled the financial resources, which are being managed by ABC Ventures. In such cases, consolidation is performed at the level where the ultimate control resides (Please refer SIC 8).

From the above it is clear that the Fund is a passive investment vehicle with no decision making power with respect to these venture projects. Therefore, the question of control does not arise which is the basic requirement for consolidation of financial statements under International Accounting Standard 27 paragraph 12. The only reason why the fund has to consolidate its financial statements with venture projects is due to the definition of subsidiary as given in Section 3 of the Companies Ordinance 1984. If the definition given in Section 3 of the Companies Ordinance, 1984 were in line with definition given in IAS 27 then in our opinion the requirement of consolidation would not have arisen.

Opinion:

First of all your attention is drawn to the following sections of the Companies Ordinance, 1984 :-

3.    Meaning of “subsidiary” and “holding company”. –

(1) For purposes of this Ordinance, a company or body corporate shall be deemed to be a subsidiary of another if-

(a) that other company or body corporate directly or indirectly controls, beneficially owns or holds more than fifty percent of its voting securities or otherwise has power to elect and appoint more than fifty percent of its directors; or

(b) the first mentioned company or body corporate is a subsidiary of any company or body corporate, which is that other’s subsidiary

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 requirement of the Fourth Schedule and International Accounting Standards notified under sub-section (3) of section 234.

In view of the above the Committee is of the opinion that as the law stands today your Fund has to consolidate all the companies in which it is holding more than 50% of voting rights whether the control of Fund over its subsidiary is there or not and there is no exception to it.

The Committee also appreciates your above-mentioned concerns and justification for not preparing the consolidated financial statements of your Fund but as you are well aware that on the basis of unwritten law that local legal requirements would have precedence over the provisions of IAS, you are therefore required to consolidate irrespective of any control if holding is more than fifty percent.

 (March 6, 2004)