In continuation with the previous two parts on preparation and presentation of consolidated financial statements (hereinafter referred as 'CFS' in this document') there could be lot of practical issues, which may or may not have been covered under the standard or possibly where there is lot of professional judgements required. The objective of this article is to share scenarios (at time it could be of only academic interest!). This article would also try to explain the differences between AS 21 and Ind AS 110, where possible.
1. Both under AS 21 and Ind AS 110, the goodwill (or capital reserve) on consolidation should be determined on the date of acquisition. What would be the scenario where the acquisition was made in tranches (creeping acquisition)?
View: Under AS 21, the goodwill or capital reserve had to be determined based on the effective holding at each date of acquisition (i.e., at every tranche or stage of acquisition) and continue to do so for further tranches as well.
Whereas, under Ind AS 110, the goodwill is determined on the date of acquisition (i.e., where the control is established). In case of any further investments, no goodwill is recognized since it is already a subsidiary and any further acquisition just increases the investment.
2. Whether there could be scenarios where a company is treated as a subsidiary under AS 21, but not under Ind AS 110?
View: Yes, there are many instances where an investment in an entity is treated as subsidiary under AS 21, based on the percentage of holding or composition of Board. Whereas, under Ind AS 110 the determination of whether an entity is subsidiary is or not, is based on the fulfilling the criteria of 'power to control relevant activities'. In which case, though a company could hold more than 51% of shares or composition of Board, but if it does not fulfill the conditions of 'power to control relevant activities'; it would not be treated as a subsidiary.
3. In continuation with the above question, how should such investments be treated in the CFS?
View: In continuation with the above question, would suggest to test the investments as follows:
- Whether it is a subsidiary - comply with Ind AS 110 / and disclosures under Ind AS 112.
- Whether it is an associate or joint venture - consolidate under equity method.
- Else, test the business model and characteristic cash flow under Ind AS 109 and fair value the same either through Statement of Profit and Loss or through Other Comprehensive Income, as the case may be.
4. How should foreign subsidiaries be consolidated?
View: Following are the major aspects to be considered:
- Ensure that the relationship between 'parent' and 'subsidiary' is established under Ind AS 110 (and not as per the local GAAP of the subsidiary, which could be quite different);
- Align the accounting policies to Ind AS (may require re-drafting of the financials for the purpose of consolidation. Further, in may jurisdictions audit of financial statements is not mandatory for companies till specific conditions are met. In those cases, these financial statements would have to be specifically audited for the purpose of consolidation. Or the management certified accounts could be consolidated. The auditor of the holding company is expected to comment on whether they have relied upon the audit reports of the subsidiary if it is audited by another independent professional in that jurisdiction or where the management certified accounts are consolidated, the auditor should clearly indicate that it is unaudited. In either of the case, the auditor has to mention in Other Matter paragraph the volume of revenue, profit, cash flows and assets which are consolidated based on the financial statements audited by another independent professional or whether they are management certified).
- Appropriate use of functional and reporting currency;
- Accounting of foreign currency translation reserve;
- Review of the Goodwill on Consolidation (to be tested for impairment);
- Consider any modifications in the audit report of the subsidiary in the report of the consolidated financial statements, appropriately;
- Where subsidiary is disposed off, the impact should be disclosed in the consolidated financial statements.
5. What are the practical challenges in consolidating subsidiary / subsidiaries?
View: Following are some of the practical challenges in consolidating subsidiary / subsidiaries:
- The goodwill on consolidation has to be determined on the date of acquisition. It is quite possible that the company may have acquired a subsidiary a long time ago; and this being the first year of preparing consolidated financial statements, it would be a challenge to retrieve the old records to determine the exact date of investment (investments, if it is a creeping acquisition) and then calculate goodwill / capital reserve.
- The businesses of the subsidiaries could be different. Hence, presentation of information in the financial statements requires significant number of disclosures and presentation changes. Say, a company has subsidiaries which are in logistics, manufacturing, real-estate business, etc., Some of the critical accounting like revenue recognition, stock valuation, etc., would be different.
- Different accounting year: The financial year of the subsidiary could be say a calendar year as per the local regulations, which is quite different in India. The standard permits to consolidate the financial statements prepared at least six months ago and making necessary adjustments to material items and giving disclosures thereto. However, practically, financial statements for the period, aligned to that of the parent company, are prepared for the ease of consolidation.
- Keeping record of reconciliation of accounts as per the local GAAP and AS / Ind AS, for future reference.
- Inter-company stock valuation - Profit on the closing stock sold not only between holding and subsidiary, but between subsidiaries also needs to be eliminated. The challenge would be if one subsidiary sells item to another; and it is capitalized. Obviously, unlike purchases and sales, Asset and Revenue cannot be eliminated. In such case, one would have to ensure to derecognize the profit and revenue appropriately.
- Recognising and presenting realignment of components as subsidiary / associate or jointly controlled entity.
- At the operational level, even the ERP or accounting packages could be different. Thereby, the chart of accounts and trial balance line items needs to be realigned with the parent company.
6. Issues arising out of Deferred Tax calculation at the consolidated financial statements level
View: Some of the issues are:
- As per Para 11 of Ind AS 12, 'the tax base is determined by reference to the tax returns of each entity in the group. In some jurisdictions, in consolidated financial statements, temporary differences are determined by comparing the carrying amounts of assets and liabilities in the consolidated financial statements with the appropriate tax base. The tax base is determined by reference to a consolidated tax return in those jurisdictions in which such a return is filed”. In India, we currently do not have the practice or provision to file consolidated tax return. Therefore, the consolidation should be done considering each jurisdiction's tax returns.
- Where companies are planning to include freehold land on a slump-sale basis, issues could arise whether deferred tax would have to be recognized or not. If deferred tax asset is created, would the company have enough earnings to offset the asset? Secondly, the valuation under Ind AS could be different from that of tax returns filed or as per tax regulations. (See ITFG 7, Issue 7).Other factors to influence the decision of deferred tax include when land is converted to inventory, use of indexation for the purposes under capital gains, etc., (See ITFG 17, issue 7).
- On transition to Ind AS, with the combined reading of Ind AS 101 and Ind AS 21, foreign exchange differences arising from translation of long-term foreign currency monetary items could have been capitalized under AS 11. However, such accounting is not permitted under Ind AS. Such differences in accounting would lead to accounting of deferred taxes (ITFG 8, Issue 8).
- Deferred taxes on undistributed profits of subsidiaries. While the dividend declared by subsidiary is eliminated against the dividend received in the Equity as a consolidation adjustment, the dividend distribution tax would be charged as an expense in the consolidated statement of profit and loss (unless it can offset this with its own dividend distribution tax liability). Ind AS 12 requires recognition of deferred tax liability on the undistributed reserves of subsidiaries except where the parent is able to control the timing of reversal of the temporary difference and it probable that the temporary difference will not reverse in the foreseeable future. (ITFG 18, Issue 2).