Corporate Reporting & Group Accounting 2024-2025 PDF

Corporate Reporting & Group Accounting 2024-2025 Amedeo Pugliese Marco Ghitti University of Padua University of Padua [email protected] [email protected] Job Description Group accountants...

Corporate Reporting & Group Accounting 2024-2025 Amedeo Pugliese Marco Ghitti University of Padua University of Padua [email protected] [email protected] Job Description Group accountants (also known as consolidation accountants) are responsible for maintaining the financial reporting within a group of companies. Group accountants may be required to consolidate the financial statements of like subsidiary companies for a group. They are responsible for preparing the group's consolidated accounts, supporting the audit process and working with the external auditors to ensure that accounts are filed with the relevant authorities. This role can be similar to that of a financial accountant, in that it can require the drafting of financial statements and potentially supporting or running the external audit process, but is focussed on the consolidated accounts of the group rather than individual entities within that group. A keen interest in technology developments pertinent to accountancy, and a considered, intentional approach to leverage them for service improvement is key. S17 Group Reporting (intro) MCQ 1 A owns 100% of B. At the end of the fiscal year A records profit for 1,000, B records profit for 500. During the year A sold to B services for 2,000 and made a profit of 400. Which one of the following is correct? A. The Group made profits for 1,000 B. The Group made profits for 1,400 C. The Group made profits for 1,100 D. The Group made profits for 1,500 MCQ 1 A owns 100% of B. At the end of the fiscal year A records profit for 1,000, B records profit for 500. During the year A sold to B services and gained 400. A. The Group made profits for 1,000 B. The Group made profits for 1,400 C. The Group made profits for 1,100 D. The Group made profits for 1,500 A typical issue (Q1) Alfa wants to expand into a new business and has the following options: 1. Investing into new assets (PPEs, Intangibles) and fund it with new equity or raise debt (organic growth). 2. Set up a new separate entity, and keep all assets/liabilities and future profit/losses in the same entity – Set up a new entity, a subsidiary A subsidiary could be owned at 100%, or Seek for additional investors to finance the venture 3. Purchase an existing firm whose asset/financing profile resembles the one Alfa is looking for. Hence: – Purchase majority (to obtain control) – Purchase a minority stake – Make a joint venture Why Consolidated Financial Statements? Why do we study the accounting of business combinations and groups? In the early 2000s it was common practice for large corporations (especially in the US) to set up controlled entities (subsidiaries) that were excluded from consolidation. These entities were either fully owned (100%) or controlled with large stakes (~ 95%) hence the control was out of question, but a specific provision under US GAAPs exempted parent companies from consolidating these Special Purpose Entities - off-balance-sheet items. These companies were vehicles through which parent (holding) companies raised debt or pursued speculative investments, but no transparent communication was offered to investors. The danger of escaping consolidation TELECOM – VIVENDI: the fight for the (lack of) control Vivendi 23,94% Cassa Depositi e Prestiti 4,93% Gruppo Telecom Italia 1,08% Italian Institutional investors 2,97% Foreign Institutional investors 55,48% Other shareholders 11,60% What would happen if VIVENDI was identified as the de facto controller of TELECOM? What happens to all assets and liabilities of TELECOM? A case in point In 2018 Michael Kors (US Company listed on the NYSE) announced to a deal to purchase 100% of shares of GIANNI VERSACE SpA: 1. VERSACE was a privately held italian firm, whose controlling owners were members of the Versace family (founders’ descendants) 2. MK paid € 1.83 BN to acquire full control 3. The book value of Equity of VERSACE at the time of acquisition was € 240 MLN 4. VERSACE’s net profits in the years prior to the acquisition: 1. 2017 (- € 8 MLN) 2016 (- € 24 MLN) 2. Average of last 7 years (~ - €200k) Was the Price paid justified? What could happen to MK’s financial statements in the years post acquisition? Group Reporting Three levels of financial reporting: – Separate financial statements for each stand-alone legal entity – Aggregate reporting for the whole economic entity (e.g. the group) – Disaggregate reporting for business units (not being legal entities) within a corporation See examples from LVMH Reporting Economic Substance? Alfa is pursing an investment in an un-related business area (e.g. diversification). Two paths seem plausible: H1: Direct acquisition of assets (e.g. License for 800 and Equipment for 1200) and paying them through increased debt (50%) and the rest through cash; H2: Acquiring 100% of Beta, who is already established in the industry. Price is 2000 of which 50% would be funded through increased debt and the rest through cash. Beta has no Profit for the year Alfa: Balance Sheet pre investment Alfa: Income Statement Beta: Balance Sheet Assets Liabilities Revenues 3200 Assets Liabilities Cash 1000 Provisions 800 Operating Expenses (900) License 400 Equity + 1400 Reserves Receivables 2800 Debt ST 2200 Depreciation (1600) Amortization Equipment 1000 Plant 5000 Debt LT 5100 Interests (100) Intangibles 1200 Equity + 1900 Reserves Net Profit 600 Reporting Economic Substance? (H1) Alfa is keen on pursing an investment in an un-related business area (e.g. diversification). H1: Acquiring Assets (e.g. License for 800 and Equipment for 1200) and paying them through increased debt (50%) and the rest through cash; The two newly acquired assets feature different useful lives. Alfa: Balance Sheet post investment Alfa: Balance Sheet pre investment Assets Liabilities Assets Liabilities Cash - Provisions 800 Cash 1000 Provisions 800 Receivables 2800 Debt ST 2200 Receivables 2800 Debt ST 2200 Plant 5000 Debt LT 5100+1000 Plant 5000 Debt LT 5100 Intangibles 1200 Equity + 1900 Reserves Intangibles 1200 Equity + 1900 License (5yrs) 800 - 160 Reserves Equipment (10 yrs) 1200 – 120 Reporting Economic Substance? (H1) Alfa is keen on pursing an investment in an un-related business area (e.g. diversification). H1: Acquiring Assets (e.g. License for 800 and Equipment for 1200) and paying them through increased debt (50%) and the rest through cash; The two newly acquired assets feature different useful lives. Alfa: Balance Sheet post investment Assets Liabilities Alfa: Income Statement Cash - Provisions 800 Revenues 3200 Receivables 2800 Debt ST 2200 Operating Expenses (900) Plant 5000 Debt LT 5100+1000 Depreciation (1600) + (160) + (120) Intangibles 1200 Equity + 1900 Amortization Reserves Interests (100) License (5yrs) 800 - 160 Net Profit 320 Equipment (10 yrs) 1200 – 120 Reporting Economic Substance? (H2 – no consolidation) Alfa is keen on pursing an investment in an un-related business area (e.g. diversification): H2: Acquiring 100% of Beta, who is already established in the industry. Price is 2000 of which 50% would be funded through increased debt and the rest through cash proceeds. Beta has no Profit for the year Alfa pays 2000 something that is worth 1400 at book value (e.g. Equity of Beta): why? Alfa: Balance Sheet Alfa: Income Statement Assets Liabilities Revenues 3200 Cash - Provisions 800 Operating Expenses (900) Receivables 2800 Debt ST 2200 Depreciation (1600) Amortization Plant 5000 Debt LT 5100+1000 Interests (100) Intangibles 1200 Equity + 1900 Is this the Reserves Net Profit 600 right way of Investment in Beta 2000 accounting for the investment? Reporting Economic Substance? (H2) Alfa is keen on pursing an investment in an un-related business area (e.g. diversification). H2: Acquiring 100% of Beta, who is already established in the industry. Price is 2000 of which 50% would be funded through increased debt and the rest through cash proceeds. Beta realizes no profit for the year Alfa pays 2000 something that is worth 1400 at book value (e.g. Equity of Beta): why? Beta: Balance Sheet Beta: Balance Sheet Assets Liabilities What is the Assets Liabilities License 400 - 80 Equity + 1400 amount of License 800 Equity + 2000 Reserves amortization Reserves under the two Equipment 1000 - 100 (profit / loss) ? hypotheses? Equipment 1200 Beta records amortization for 80+100 in its Income Statement; whereas Alfa is paying a higher value for those same assets with higher charges for amortization/depreciation (160+120) Intra-Group Transactions and Financial Reporting Alfa Delta 1 and Delta 2 are operating companies (e.g. produce goods) Gamma 2 is the commercial entity and sells Beta 1 Beta 2 products on the market. Delta 1 and Delta 2 sell semi-finished products to Gamma 2 at below market price (e.g. if Gamma would want to buy the same products Gamma 1 Gamma 2 Gamma 3 should pay more) How would you interpret financial statements of Delta 1, Delta 2 and Gamma 2? Who realizes profits? Delta 1 Delta 2 Who is overvaluing inventory in their BS? Group Reporting: multidivisional company vs. group XTZ INC Division 1 Division 2 Division 3 One single legal entity organized in three different divisions Do they Exchange goods or services? Do the divisions prepare financial statements at the end of the FY? Group Reporting: multidivisional company vs. group GXT INC Ulysses1 Ulysses2 Ulysses3 LTD LTD LTD Fours separate legal entities owned by GXT Do they Exchange goods or services? Do the entities prepare financial statements at the end of the FY? Group Reporting: multidivisional company vs. group Asset 500 XTZ INC Division 1 Division 2 Division 3 Asset 100 Asset 200 Asset 150 One single legal entity organized in three different divisions Do they Exchange goods or services? Do the divisions prepare financial statements at the end of the FY? What is the total value of assets reported in XTZ’ Balance Sheet? 950? 500? Or 450? Group Reporting: multidivisional company vs. group Asset 500 GXT INC Ulysses1 Ulysses2 Ulysses3 LTD LTD LTD Asset 100 Asset 200 Asset 150 Fours separate legal entities owned by GXT Do they Exchange goods or services? Do the entities prepare financial statements at the end of the FY? What is the total value of assets reported in GXT Consolidated Balance Sheet? 950? 500? Don’t know? Q3 How many financial statements will be issued at the end of the year for this group? R&D Division 9% DELTA Ltd ALPHA PLC Logistics Division 100% 100% 90% GAMMA BETA Ltd TETA Ltd Ltd Group Reporting How are Ulysses 1, Ulysses2 and Ulysses3 reported in GXT’s Fin Statements? GXT’s financial statement report the equity investment at the historical cost Investments in GXT’s financial report the dividends paid by Ulysses 1,2, and 3 Controlled Entities Ulysses 1 100 Ulysses 2 200 Ulysses 3 150 Three immediate questions? Would aggregating the Fin Statements be a solution? Is this is enough? How do you evaluate the profitability of the investments? Group Reporting Information usefulness of aggregate financial statements: – A firm (legal entity) may exercise control over other legal entities – In that case applying the principle of substance over form the financial reporting has to be extended beyond the legal entity and considers the group of companies – In the presence of a group the separate financial statement may be misleading for solvency and performance evaluation – Knowing detailed information about individual companies does not permit to have a clear picture of the group of companies as a whole Group Reporting Inter‐firms relationships – Relationships may take several forms Networks Franchising Licensing Normal business transactions Control All types of inter‐firms relationships may impair the informativeness of separate financial reporting. Why? In the presence of control there is the obligation to report consolidated financial statement – The power to control other entities creates an effective relationship between the controlling entity and the controlled entities. LVMH Group LVMH Group