Corporate and Financial Accounting: Consolidation vs Equity Accounting

This report discusses the differences between consolidation accounting and equity accounting in corporate and financial accounting. It explains the treatment of intra group transactions and their effect on non-controlling interest. The report also explores the changes required to ensure correct consolidated financial statements and their impact on disclosure requirements.

Corporate and financial accounting
Module Number-

Executive summary
A reporting entity’s accounting for the interest held in other legal entity depends upon
the ownership share held by it. Ownership of 50% or more results in control, while ownership
given between 20% to 50% results in exercise of significant influence. The accounting when
the reporting entity holds control is done according to the acquisition or purchase method as
specified by the AASB 3, Business Combinations. In this case consolidated financial
statements as required by AASB 10, and AASB 127 have to be followed. When, there is
only a significant influence, the provisions of AASB 128, Investments in Associates and Joint
Ventures are followed. Every disclosure as provided for stand-alone financial statements are
to be provided for consolidated financial statements in the annual report by the reporting
entity, including separate disclosure for Non-controlling interests.

Table of Contents
Executive summary...............................................................................................................................1
Introduction...........................................................................................................................................2
Part A Response....................................................................................................................................2
Part B Response.....................................................................................................................................5
Treatment of intra group transactions................................................................................................5
Effect upon the non-controlling Interest (NCI) calculation in the subsidiary’s annual profit.............5
Part C response......................................................................................................................................6
Changes required to ensure that the consolidated financial statements are correctly stated...............7
Effect on the disclosure requirements in the annual report................................................................7
Conclusion.............................................................................................................................................8
References.............................................................................................................................................9

Introduction
The current report emphasises the importance attached with the business
combinations attached to an entity. The difference existent between the different methods of
business combinations being equity accounting and Consolidation accounting is being
discussed with analysis of key demarcating areas between the both. Analysis of AASB 3:
Business Combinations, AASB 128 Investments in Associates and Joint Ventures and AASB
10 Consolidated Financial Statements, AASB 127 Consolidated and Separate Financial
Statements and AASB 101 Presentation of Financial Statements is undertaken. The treatment
of intra group transactions is explained considering the examples from the case study
presented. Finally the effects of disclosure of Non-Comprehensive Income in the
consolidated financial statements are considered. There are several accounting standards
which helps organization to strengthen the reporting frameworks and make the proper
transparency in the recorded items given in the books of account. Nonetheless, IAS 136 helps
in finding out the impairment loss which company would have in its assets by using the
impairment testing methods. This will help in keeping the true and fair view of the recorded
assets in the books of accounts (Auditing and Assurance Standards Board, 2015b)
Part A Response
It is analysed that Consolidation Accounting and Equity Accounting both are different than
each other and used by company to strengthen the recording frameworks and helps in setting
up harmonization in accounting and reporting frameworks. The key differences in
methodology between Consolidation Accounting and Equity Accounting are depicted as
follows (Auditing and Assurance Standards Board, 2015b)
Consolidation Accounting Equity Accounting
This method is also known as Acquisition or
purchase method. As per AASB 3 Business
Combinations the consolidation method can
be applied when the reporting organisation
have a controlling financial interest over the
operations of the legal entity (i.e. in which
As per AASB 128 Investments in Associates
and Joint Ventures this method is applied
when the reporting organisation is entitled to
exercise a significant influence over the
business of legal entity, but there is no
entitlement to exercise full control (Dagwell,

investments are made). Wines, and Lambert, 2015).
Control is exercised when the ownership in
the legal entity by the reporting entity
exceeds 50% or is equal to 50% (Su, and
Wells, 2018).
Significant influence is exercised by the
reporting entity when ownership in the legal
entity falls in between 20 to 50%.
In consolidation accounting method a
combination has to be done of the financial
statements i.e. the statement of financial
position and statement of financial
performance of both the reporting and legal
entity. a set of consolidated financial
statements is presented to the users (Bugeja,
and Loyeung, 2017).
In equity method, no consolidation of the
financials of the reporting entity and legal
entity takes place. The reporting entity
prepares stand-alone financial statements as
always prepared and presented. Only the
accounting for the investment made is
represented on the asset side of the statement
of financial performance and the income
received upon the investment is accounted as
other incomes are accounted in the income
statement.
Due to the applicability of AASB 10,
Business Combinations, the intra group
transactions effected between the reporting
entity and the legal entity, i.e. between the
parent and the subsidiary shall be completely
eliminated while preparation of the
consolidated set of financial statements.
e.g.: profit arising to subsidiary on inventory
sale to parent, shall be eliminated while
consolidating the income statement and
Until and unless the legal entity is a
subsidiary as per AASB 3, no intra group
transactions are required to be eliminated.
This is because the provisions of AASB 10 in
relation to consolidation of the financial
statements of reporting and legal entity do
not apply when equity method prevails, i.e.
where only significant influence is exercised.

balance sheet.
The terminology used for the reporting entity
here is “parent”; while for the legal entity is
“subsidiary” (Masadeh, Mansour, and AL
Salamat, 2017).
Here no such terminology is used the legal
entity however is named as “affiliate” or as
“associate” (IASB, 2015).
Example: if JKY Limited acquires 50%
shares of FAB Ltd, the consolidated method
of accounting as per AASB 3, Business
Combinations shall be applied by JKY
Limited for its reporting.
Then, as per AASB 10, Consolidated
Financial Statements, JKY Limited shall be
required to prepare a consolidated set of
financial statements. It means the
consolidated financial statements shall be
made by adding 50% of share of revenues,
assets, expenses, and liabilities of FAB Ltd.
So if FAB Ltd earns a revenue of $50 million
and JKY Limited earns a revenue of $100
million, then the revenue computation shall
be as follows:
JKY Ltd.’s share in revenue of FAB Ltd shall
be 50% of $50, i.e. $25.
Revenue of JKY Ltd: $100
Revenue of FAB Ltd: $25
Consolidated revenue: $125
Example: If JKY acquires 25% of shares of
FAB Ltd at $10,000, acquisition entry shall
be:
Dr. investment in FAB Ltd $10,000
Cr. Cash $10,000
Here the investments in FAB Ltd shall be
shown on the asset side of balance sheet. Any
income accrued on this investment shall be
treated in profit and loss account. Dividend
received shall for a part of income.
Nonetheless, profit arising to subsidiary on
inventory sale to parent, shall be eliminated
while consolidating the income statement and
balance sheet (Auditing and Assurance
Standards Board, 2015b)

Part B Response
The discussion for the treatment of intragroup transactions arise only when an entity
controls 50% or more of another entity and the method followed is consolidation or
acquisition method as per the AASB 3, Business Combinations. In this case, there comes
requirement at the end of reporting period to formulate consolidated financial statements by
following the provisions of AASB 127 Consolidated and Separate Financial Statements and
AASB 10 Consolidated Financial Statements. All the companies having the consolidated
balance sheet are required to file the same to the reporting authority disclosing the balance
sheet of other subsidiary companies. If any of the party found to be in relation to the other
party then it is required to disclose all the details to other party and stakeholders of the
company before entering into the contract or business transactions (Auditing and Assurance
Standards Board, 2015b)
Treatment of intra group transactions
 While preparation of consolidated financial statements, the assets, liabilities, expenses and
incomes of both the parent entity and subsidiary entity are not just unambiguously added, but
the formation of the consolidated financial statements happens considering both the entities
as a single economic entity.
 Paragraph 20 of AASB 127 mentions elimination of the intragroup income, expenses,
transactions and balances in full. Along with these transactions it is clearly specified by the
Paragraph 21 of AASB 127 to completely eliminate the profits and losses which result from
intragroup transactions and are recognised as a part of assets should also be completely
eliminated. Also the provision lays out the applicability of AASB 12 Income Tax upon the
temporary differences which resulted from the profits and losses that are eliminated. AASB
10 also sets same provision as an accounting requirement for consolidation procedure (Haier,
Molchanov, and Schmutz, 2016).
Effect upon the non-controlling Interest (NCI) calculation in the subsidiary’s annual
profit
 The non-controlling interest is represented by all the ownership interest in the subsidiary of
the reporting entity other than that of the reporting entity. The subsidiary’s annual profit is
divided into two parts, one is the share of parent i.e. reporting entity and the other of non-

controlling interest. Due to elimination of unrealised profits affected as a result of intra group
transactions where in the subsidiary sells to parent, the accounting profit of the subsidiary
falls. Vice-versa happens in elimination of unrealised losses. However, the accounting profit
of subsidiary is affected when the subsidiary is the seller and had made some profit or loss on
sale. This accounting profit if changes due to unrealised profits and losses being eliminated
due to elimination of intra group transactions hence effects the computation of non-
controlling interest (Lee, P.J., Tavallali, R. and Lee, 2017).
The key points discussed in the relation of intragroup transaction elimination and its effect
upon the accounting profit of subsidiary which is attributable to the non-controlling interest
can be studied with the help of the following example (Auditing and Assurance Standards
Board, (2015b)
Suppose the ownership of JKY Ltd in its partially owned subsidiary is of 70%. The
professional service provisioning and inventory sale is made to JKY Ltd at $5000 and
$6000 respectively. The cost to subsidiary for both had been $4000 and $5000
respectively. Inventory is still lying unsold with parent. the accounting profit reported
by subsidiary had been $20000 for the year which has to be divided in the ratio of 70%
and 30% between parent and non-controlling interest. The treatment shall be as
follows:
 Firstly, as per AASB 127 and AASB 10, the effect of intragroup transactions has to be
eliminated. Resultant, the preparation of consolidated financial statements shall require the
consolidated inventory amount to be reduced by the unrealised profit amount. Unrealised
profit in case of inventory shall be $1000 ($6000-$5000). Accounting profit of $20,000 shall
also fall by same amount.
 Secondly, the unrealised profit of $1,000 ($5000-$4000) on provision of professional service
shall also reduce the accounting profit.
 Hence, the accounting profit shall be $18000, being $12,600 attributed to parent and $5400
attributed to non-controlling interest as compared to earlier attributable amount of $6000 to
the non-controlling interest. Due to elimination of intra group upstream transactions, the
accounting profit attributable to non-controlling interest has fallen.

Part C response
AASB 127 lays the requirement to separately report non-controlling interest in the
consolidated financial statements. This non-controlling interest is also allocated the Other
Comprehensive Profit. The subsidiary of JKY Ltd is reported to be recording assets at
historic cost (Bodle, Brimble, Weaven, Frazer, and Blue, (2018).
Changes required to ensure that the consolidated financial statements are correctly
stated
AASB 127 requires adoption of uniform accounting policies by all the members whose
financials are consolidated as a group by the parent or reporting entity. The consolidated
financial statements shall be prepared by the group only by incorporating accounting policies
that are uniform. in case the accounting policies followed by any member differ from the
group, an adjustment is required in its policies to bring them in conformity with the
accounting policies of the group. By using the uniform accounting policies, company could
easily set up proper harmonization in its recording frameworks and helps in strengthen the
recording frameworks as per the AASB 127. Nonetheless internal audit program will also be
set up to assess the changes made in the accounting frameworks of the company (Brunelli,
2018).
Here, in this case if JKY Ltd is using the fair value method to value assets and record assets,
then the financials of the subsidiary shall be adjusted accordingly. The assets of subsidiary
which have till now been recorded at cost shall now have to be recorded at fair value. These
are the changes which are required to ensure that the consolidated financial statements are
correctly stated (Yang, and Aquilino, 2017).
Effect on the disclosure requirements in the annual report
AASB 127 requires attribution of other comprehensive income to the non-controlling interest
even if the balance of NCI turns deficit after that. Other comprehensive income shall also be
separately shown attributable to the non-controlling interest in the financial statements of the
parent as per the requirements of AASB 101, Presentation of Financial Statements. The
disclosures required have to be made in stand-alone financial statements for other
comprehensive income and non-controlling interest are also the same for consolidated sets of
financial statements (Schwarzbichler, Steiner, and Turnheim, 2018).

In the given case to accommodate the fair value accounting for the assets of subsidiary, the
effects shall be reflected through the other comprehensive income section of the income
statement. If the asset is re-valued upwards, the effect shall be directly observed in the other
comprehensive income by opening a revaluation surplus on the other end. In the annual
report presented with the consolidated financial statement, the disclosures have to be made
for:
 The adjustments made in the financials of the subsidiary entity to adopt the revaluation model
for assets than the historical cost to make the accounting policies consistent with that of JKY
Ltd.
 The effect of the revaluation upon the other comprehensive income.
 The allocation of the other comprehensive income to the parent and the non-controlling
interest shown separately (Gluzová, 2016).
 The overall effect of the additions or deductions on the other comprehensive income and the
resultant effect on the share attributable to the non-controlling interests.
 Every disclosure as provided for stand-alone financial statements needs to be provided for
consolidated financial statements in the annual report by the concerned reporting entity. In
addition to this, notes to accounts and separate disclosure is also required for the same.
 Due to the applicability of AASB 10, Business Combinations, the intra group transactions
found to be affected between the reporting entity and the legal entity, i.e. between the parent
and the subsidiary, will be completely eliminated while preparation of the consolidated
financial statements.
 Implication of the AASB 127, consider the disclosure of Non-Comprehensive Income in the
consolidated financial statements are considered. It helps in strengthen the transparency of
the Non-Comprehensive Income in the consolidated financial statements recorded in the
books of account (Chaplin, 2016).
Conclusion
All the accounting standards are followed by company to prepare the financial
statements to set up uniformity and establish the harmonization in the international and
domestic reporting frameworks. Nonetheless, AASB 127 requires adoption of uniform
accounting policies by all the members whose financials are consolidated as a group by the
parent or reporting entity. However, AASB standards have been followed with the
implication of the treatment of intra group transactions and proper explanation regarding

considering the examples from the case study presented. This helps company to strengthen
the reporting framework and making the changes required for preparing the consolidated
financial statements. Separate accounting standards are formulated for accounting as per
consolidated method or as per equity method. These have to be followed stringently when an
entity accounts such transactions. Non-adoption of such standards can lead an organisation in
legal trouble. It is analysed that the non-controlling interest is represented by all the
ownership interest in the subsidiary of the reporting entity other than that of the reporting
entity and annual profit of subsidiary company is divided into two parts, one is the share of
parent i.e. reporting entity and the other of non-controlling interest. This shows that there
needs to be proper disclosure of the recorded assets in the books of account of company.

References
Arena, M. and Sarens, G. (2015). Editorial: Internal Auditing: Creating Stepping Stones for the
Editorial. International Journal of Auditing, 18(1), pp.1-1
Auditing and Assurance Standards Board, (2015b) Auditing Standard ASA 136 Communicating Key
Audit Matters in the Independent Auditor’s Report. Available on:
https://www.auasb.gov.au/admin/file/content102/c3/12-
15_AI_5.31_New_Auditing_Standard_ASA_701_(mark-up)_electronic.pdf [Accessed on 11/05/19
Bodle, K., Brimble, M., Weaven, S., Frazer, L., and Blue, L. (2018). Critical success factors in
managing sustainable indigenous businesses in Australia. Pacific Accounting Review, 30(1), 35-51.
Brunelli, S. (2018). The Firm’Going Concern in the Contemporary Era. In Audit Reporting for Going
Concern Uncertainty (pp. 1-25). Springer, Cham.
Bugeja, M. and Loyeung, A., 2017. Accounting for business combinations and takeover premiums:
Pre-and post-IFRS. Australian Journal of Management, 42(2), pp.183-204.
Chaplin, S. (2016). Accounting Education and the Prerequisite Skills of Accounting Graduates:
Future. International Journal of Auditing, 19(3), pp.131-133.
Dagwell, R., Wines, G. and Lambert, C., 2015. Corporate accounting in Australia. Pearson Higher
Education AU.
Gluzová, T., 2016. Disclosure of subsidiaries with non-controlling interest in accordance with IFRS
12: case of materiality. Acta Universitatis Agriculturae et Silviculturae Mendelianae
Brunensis, 64(1), pp.275-281.
Haier, A., Molchanov, I. and Schmutz, M., 2016. Intragroup transfers, intragroup diversification and
their risk assessment. Annals of finance, 12(3-4), pp.363-392.
IASB, F., 2015. Revenue from Contracts with Customers. Exposure Draft.
Lee, P.J., Tavallali, R. and Lee, S., 2017. Recognizing a Parent and Subsidiary Gain or Loss in
Indirect Intercompany Bond Transactions. International Research Journal of Applied Finance, 8(1),
pp.39-46.

Masadeh, W., Mansour, E. and AL Salamat, W., 2017. Changes in IFRS 3 Accounting for Business
Combinations: A Feedback and Effects Analysis. Global Journal of Business Research, 11(1), pp.61-
70.
Schwarzbichler, M., Steiner, C. and Turnheim, D., 2018. Acquisitions: Impact on Consolidated
Financial Statement. In Financial Steering (pp. 265-341). Springer, Cham.
Su, W.H. and Wells, P., 2018. Acquisition premiums and the recognition of identifiable intangible
assets in business combinations pre-and post-IFRS adoption. Accounting Research Journal, 31(2),
pp.135-156.
Yang, J.G. and Aquilino, F.J., 2017. Measuring goodwill and noncontrolling interest under the new
consolidation accounting standards. Journal of Financial Reporting and Accounting, 15(2), pp.198-
207.