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Essay: Consolidation

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  • Subject area(s): Finance essays
  • Reading time: 3 minutes
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  • Published: 19 September 2015*
  • File format: Text
  • Words: 611 (approx)
  • Number of pages: 3 (approx)

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Under IFRS, consolidation is appropriate when an entity has the ability to govern the financial and operating policies of another entity to obtain benefits. Control can be represented when a parent owns more than 50 percent of an entity’s voting power. If the parent does not own more than 50 percent, however, a legal or contractual right will support the parent’s ability to control the subsidiary’s voting power or board of directors. Based on this criteria for IFRS consolidation, both Centcom and TTL Group have to consolidate Britel in their year-end financial statements. Both companies have significant influence and control over Britel in regards to its profits, losses, and operation. Centcom has significant influence because they are managing Britel’s entire business. TTL Group has significant influence because they select five out of six members on Britel’s board of directors, which constitutes having significant influence over Britel. While Centcom may have the majority of the liability, and TTL Group has so little, the International Accounting Standards Board (IASB) typically requires that all entities exhibiting control over another company has to follow a consolidation model (Advanced Accounting 5E, Hoyle). This requirement emphasizes the difference between GAAP and IFRS. GAAP requires that one parent company has to consolidate their financial statements with an entity if they own fifty percent or more of the company in regards to voting rights and power within the company. On the other hand, IFRS states that all companies holding significant influence with the entity has to consolidate it in their financial statement in terms of percentage-owned. The IASB reasoned that using this standard could help avoid other standards that are created to favor a company’s accounting outcome rather than their actual accounting (Advanced Accounting 5E, Hoyle). This enables an investor to invest in a company with full disclosure.
In order for a consolidation to occur under GAAP, there must exist a Variable Interest Entity and Primary Beneficiary. To identify itself as a Variable Interest Entity, one of two requirements must exist: 1) the total equity at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by any parties or 2) either: the equity investors do not fully participate in residual returns or losses, do not have substantive voting rights, or have voting rights that are disproportionate to their economic exposure. Britel cannot fully finance their operations because the contract stipulates that ‘Centcom will be required to fund any shortfall’. Alternatively, in order for an entity to be the primary beneficiary of the VIE both characteristics must exist: 1) the power to direct the activities that most significantly impact the VIE’s economic performance and 2) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. Centcom fulfills both requirements because not only do they select one member of the six-member board of directors and have written call options that will purchase 100 percent of Britel’s outstanding shares, but they also ‘manage the administrative and operational activities of Britel’. Additionally, the contract specifies that Centcom would be ‘entitled to receive 80 percent of Britel’s EBTIDA during the agreement period’. Because both Centcom and Britel qualify as a parent and VIE respectively, Centcom should consolidate Britel under GAAP. Alternatively, TTL Group should not consolidate Britel under GAAP. Even though Britel is a wholly owned subsidiary, TTL must assess if it is a primary beneficiary. TTL does have power because they select five of six board of directors members. However, because TTL does not absorb any potential loss, nor fund any of Britel’s operations, they should not consider themselves as a primary beneficiary.

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