Group Accounting and Theories of Consolidation 2024 PDF

ACCOUNTABILITY GOVERNANCE AND REGULATION II Group accounting and Theories of consolidation Chiara Saccon Venice, 2024 3  Programme and study materials Accounting Regulation (slides and Leuz article) TEXTBOOK: I...

ACCOUNTABILITY GOVERNANCE AND REGULATION II Group accounting and Theories of consolidation Chiara Saccon Venice, 2024 3  Programme and study materials Accounting Regulation (slides and Leuz article) TEXTBOOK: IFRS regulation – Chapter 2 IFRS: an overview Consolidation according to theories (slides) IFRS Consolidation: when to consolidate – Chapter 4 Consolidated financial statements IFRS Consolidation: how to consolidate IFRS Consolidation: how to consolidate – Chapter 3 Meaning of consolidation – Chapter 5 Combining individual financial statem. – Chapter 6 More on consolidation accounting  Group accounting Group and consolidation The economic world is dominated by enterprises that are structured as groups, each comprising a large number of legally separate entities Not a unique definition of group but need for group representation The group accounting representation: consolidated annual report  Group accounting Reasons for such complex structures Entities need to be legally separate because they operate in different countries under different laws There are tax advantages in being separate or there would be tax disadvantages in combining formerly separate entities The legal structure may partially reflect a hierarchical organizational structure or the way in which the group was put together over time  Group accounting Group features: Separate legal entities Entities act together as they were a single economic entity Formal and substantial relationship Different approches to the group interpretation and consequently different accounting representation Regulation takes different approaches  Group accounting Group accounting representation: Consolidated financial statements (CFSs) Meaning and relevance of CFSs – Role of CFSs: to inform readers on how well the group as a whole is performing in order to make decisions – Individual financial statements of single entities are not enough and could provide misleading information on the group ‘s overall performance (see example p. 50-53) ➔Consolidation needed  Group accounting Process of consolidation Entities selection (perimeter of consolidation) Managing differences (date, classification and evaluation criteria, currencies) Summarizing individual annual reports and consolidation adjustments ➔ Not a unique accounting behavior but several solutions  Group accounting Different Approaches to Consolidation Several different theories of consolidation exist that might serve as a basis for preparing consolidated financial statements. The choise of consolidation theory can have a significant impact: – on the perimeter identification – on the consolidated financial statements in those cases where the parent company owns less than 100 percent of the subsidiary’s common stock.  Group accounting Different Approaches to Consolidation Alternative main theories of consolidation: – Proprietary – Entity Other derived theories: Proprietary vs Entity: pure proprietary theory, equity method, parent company theory, modified parent company theory, entity theory  Group accounting Proprietary Theory The proprietary theory of accounting views the firm as an extension of its owners The assets and liabilities of the firm are considered to be assets and liabilities of the owners themselves Similarly, revenue of the firm is viewed as increasing the wealth of the owners, while expenses decrease the wealth of the owners  Group accounting Proprietary Theory Perimeter is based on formal control When applied to the preparation of consolidated financial statements, the proprietary concept results in a pro rata consolidation The parent company consolidates only its proportionate share of the assets and liabilities of the subsidiary  Group accounting Parent Company Theory The parent company theory is perhaps better suited to the modern corporation and the preparation of consolidated financial statements than is the proprietary approach The parent company theory recognizes that although the parent does not have direct ownership of the assets or direcct responsability for the liabilities of the subsidiary, it has the ability to exercise effective control over all of the subsidiary’s assets and liabilities, not simply a proportionate share  Group accounting Parent Company Theory Under parent company theory, separate recognition is given in the consolidated balance sheet to the noncontrolling interest’s claim on the net assets of the subsidiary and in the consolidated income statement to the earnings assigned to the noncontrolling shareholders  Group accounting Entity Theory As a general rule, the entity theory focuses on the firm as a separate economic entity, rather than on the ownership rights of the shareholders of the parent or subsidiary Perimeter is based on substantial control Emphasis under the entity approach is on the consolidated entity itself, with the controlling and noncontrolling shareholders. Neither of the two groups is emphasized over the other or over the consolidated entity  Group accounting Entity Theory Because the parent and subsidiary together are viewed as a single entity (under the entity approach), all the assets and liabilities of the subsidiary and any goodwill are reflected in the consolidated balance sheet at their full values on the date of combination regardless of the actual percentage of ownership acquired Additionally, all expenses and revenues of the entities determine the group economic result