Before going into lexus nexus of the law let us understand in layman’s terms what does controlled enterprises mean and why are they required to be consolidated. A controlled enterprise can be termed as any entity or a person over which another entity or person has significant control or is in position to influence that other entity or person. And due to existence of such control the financial snapshot of an entity on standalone may not give a correct picture of the entire operations of the entity. Hence in favor of greater transparency consolidated financial statements are prepared to present fair and holistic view of an entity’s overall performance.
Coming to the law, Section 129 (3) of Companies Act 2013 mandates preparation of consolidated financial statements (‘CFS’) by all companies having one or more subsidiaries, associate company or joint venture in accordance with with Schedule III and applicable accounting standards. Further, Ind AS 110 – Consolidate Financial Statements provides that, where an entity has control on one or more other entities, the controlling entity is required to consolidate all the controlled entities. Similarly, AS 21 also requires an enterprise controlled by the parent to be consolidated. Since, the word ‘entity’ includes a company as well as any other form of enterprises, even LLPs and partnership firms are required to be consolidated.
The first call to action in preparing CFS is identifying which entities are subsidiaries, associates and Joint Ventures. Let us understand how law defines each of such entities.
Section 2(87) of Companies Act 2013 defines subsidiary company, as a company in which the holding company:
(i) Controls the composition of the Board of Directors; or
(ii) Exercises or controls more than one-half of the total voting power either at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed. (Effective from 20-09-2017)
Ind AS 110 defines subsidiary company as, “an entity that is controlled by another entity.”Associate Company:Section 2(6) of companies Act 2013 states “associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.
Explanation.—For the purposes of this clause, “significant influence” means control of at least twenty percent of total share capital, or of business decisions under an agreement;
Whereas IND AS 28 defines associate as, “An enterprise in which the Investor has significant influence and which is neither a subsidiary nor a joint venture of the investor.”
Companies Act does not define Joint Venture, however AS 27 states:
A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity, which is subject to joint control.
Ind AS on the other hand brings in the concept of ‘Joint Arrangement’. Ind AS 111 defines the same as an arrangement of which two or more parties have joint control. Where, a joint arrangement can be either a joint operation or a joint venture.
Exemption from preparing the Consolidate Financial Statements:A holding company is not required to consolidate the financial statements of those subsidiaries which are:
Temporary: Shares are held by holding company with an intent to dispose them in near future; or
Restriction: There are long term restrictions on transfer of funds from subsidiary to the holding company.
Further, second provisio to Rule 6 of Companies (Accounts) Rules, 2014, provides that a company is not required to prepare CFS, if it meets the following condition:
1.It is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company and all its other members, including those not otherwise entitled to vote, having been intimated in writing and for which the proof of delivery of such intimation is available with the company, do not object to the company not presenting consolidated financial statements;
2.It is a company whose securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India; and
3.Its ultimate or any intermediate holding company files consolidated financial statements with the Registrar which are in compliance with the applicable Accounting Standards.
Consolidation Procedure: Line –By- Line basis
The purpose behind preparing CFS is to present the financial statements of a parent and its subsidiaries as if they were a single economic entity. Hence the individual balances of the parent and its subsidiaries are aggregated on line-by-line basis. A summary of the steps undertaken to prepare CFS are given below:
Carrying amount of Holding Company’s Investment and its portion of equity are eliminated;
In case cost of acquisition for holding company exceeds the acquirer’s interest goodwill is calculated. Similar in the opposite situation capital reserve is calculated;
Intragroup transactions, including revenue, expenses and dividends are eliminated;
Unrealised profits from intragroup transactions, that are included in the carrying amount of assets such as inventory or other assets are eliminated;
Unrealised losses from intragroup transactions that are eliminated in arriving at carrying amount of assets;
Miority Interest in the net income of the consolidated subsidiaries are identified and adjusted against the income of the group in order to arrive at the net income attributable to the holding company’s share in the subsidiaries; and
Minority interests in the net assets of consolidated subsidiaries are identified and presented in the consolidated balance sheet separately.
Consolidation of Associate
The above steps explains the procedure followed for consolidating subsidiaries. In case of the associates and joint ventures generally equity method is used. Under equity method, investment in associate is recorded at cost by holding company. Subsequently, the carrying amount is increased or decreased to recognize the investor’s share in profits or losses of the associate.
Consolidation of Joint Venture
Proportionate consolidation method is adopted, whereby a venturer’s i.e. holding company share of each of assets, liabilities, income and expenses of a jointly controlled entity is reported as separate line item. All steps as performed for consolidating a Subsidiary are carried out, with the only difference being that when consolidated balance sheet is prepared, only proportionate share of each assets and liabilities is added.