Answer all questions:
1.What is a minority interest/non-controlling interest and how is it shown in consolidated financial statements?
In order to control a subsidiary, a parent company does not need to purchase all the shares of another company to gain control. It just needs to purchase the shares with more than 50 percent. The holders of the remaining shares are collectively referred to as the minority interest. They are part owners of the subsidiary, usually less than 50 percent. In such a case, therefore, the parent does not own all the net assets of the acquired company but does control them.
One of the purposes of preparing group accounts is to show the effectiveness of that control and of the directors of the parent company who are responsible for it. In the consolidated financial statement, minority interest of the balance sheet represents the net assets of the holders with minority remaining shares; in the income statement, minority interest represents the net profit of the holders with minority remaining shares.
For example, a parent company acquired 70% of common shares in a subsidiary, the minority interest in the consolidated financial statement equal to:
30% × common shares XX
30% × other shares XX
30% × retained earnings XX
30% × any revolution in assets XX
Minority interest XX
Therefore all of the net assets of the subsidiary will be included in the group balance sheet and the minority interest will be shown as partly financing those net assets. In the group income statement the full profit of the subsidiary is included and the minority interest in it then deducted. (Elliot, B., and J. Elliot, 2006:526)
2. ‘Disclosure of related party transactions (e.g., transactions involving parent and subsidiaries) in consolidated financial statements provides no useful information’. Discuss this statement
3. Explain the limitations of consolidated financial statements?
Consolidated financial statements are the statements which reflect financial conditions, cash flows, and operating profit of parent company and all his subsidiaries. Consolidated financial statements have adjustments for intra-transactions between parent company and subsidiaries, subsidiary and subsidiary. Consolidated financial statements have some limitations inevitably.
1. The limitation from the quality of information
1.1 Firstly, consolidated financial statements reflect the financial conditions of the whole enterprise group, but it can’t reflect each entity, parent company or subsidiary, in enterprise group. The individual operating conditions and economic performance of each subsidiary within enterprise group can’t be revealed in the consolidated financial statements. The data of consolidated financial statements is in effect the merger of the parent company and each subsidiary, so the number does not reflect the long-term and short-term debt paying ability of each legal entity.（Yinglan H and Xufang W, 2008:136）
1.2 Secondly, as the trend of internationalization develop, more and more subsidiaries are set up aboard. In some consolidated financial statements of multinational corporations, the currencies may be different used by the corporations. So the different currencies have to exchange for a uniform currency used by parent company. But in different countries, degrees of inflation reflect purchasing power of currencies. In the process of exchange, it also affected by exchange rate, interest rate, economic policy of local government. These conditions make the quality of information of the consolidated financial statements are subject to certain affected.
2. The limitation from accounting policies
If enterprises use different accounting policies to deal with the same transaction, they would get different financial results. Sometimes the data varied widely, resulting in the incomparability of financial data.
On the one hand, accounting systems in different industries are different. Enterprise groups in the preparation of consolidated financial statements are inconvenience due to accounting subjects and accounting policies are inconsistent between different trades and industries.
On the other hand, consolidated financial statements combine the individual corporate financial statements of different regions and sectors, causing profitability, risk level of enterprises have been concealed. Especially the standards of financial indicators to measure in various industries are different, lead to financial analysis and financial forecasting meaning of consolidated financial statements greatly reduced after some individual financial statements combining. （Yinglan H and Xufang W, 2008:137）
Based on the above two aspects, leading to the fundamental role of consolidated financial statements for stakeholders to provide decision-useful accounting information, have been severely weakened. For example, when the parent company is industrial enterprise and the subsidiary is financial enterprise, the consolidated statements of some items may be lost meaning due to the merger.
3. The limitation from practical controlling
Consolidated financial statements reflect the assets, liabilities, equity, revenues, expenses, profits and other accounting items that the parent company can’t fully control, burden and disposal, which includes the elements of subsidiary. Although consolidated financial statements can provide information about the enterprise group’s financial conditions, management performance and cash flows to shareholders of the parent companies, but can’t provide shareholders information with assessing and predicting the future dividends’ distribution. Even if the consolidated financial statements reflect a large number of retained earnings, and have strong ability to pay, it does not guarantee the parent companies included in the consolidated financial statements can be distributed dividends. Whether the dividends can be distributed depending on the information provided in the individual financial statements.