Corporate Takeover Decision Making and the Effects on Consolidation Accounting

This report evaluates the accounting standards issued by AASB related to corporate takeovers and consolidation accounting. It provides guidance on the best measures for successful takeovers and discusses NCI disclosures in consolidated statements.

Running head: CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON CONSOLIDATION
ACCOUNTING
Name of the Student
Name of the University
Author Note

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
Executive Summary
The main reason for preparing this report is to evaluate the accounting standards issued by
AASB, which are relevant to the process of taking over another company. Concepts like
combinations in business, intra-company transactions and NCI guidelines form a major part of
the report. These concepts are understood with the help of various scholarly articles and by
following the guidelines involved in the consolidation of financial statements. The knowledge
acquired from these standards is applied in the case of JKY Ltd. to provide guidance to the
company about the best possible measures that it should follow to successfully takeover the
other company. The report concludes by understanding the process of NCI disclosures in the
consolidated statements of accounts.

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
Table of Contents
Introduction...........................................................................................................................................3
Response to Part A.............................................................................................................................3
Response to Part B.............................................................................................................................4
Response to part 3..............................................................................................................................6
Issues from Consolidation Process..................................................................................................7
Conclusion............................................................................................................................................8
References...........................................................................................................................................9

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
Introduction
Equity form of accounting is a method that is used to measure the amount that a
holding company has invested in the subsidiary company by measuring the important aspect
called the net value of assets (assets reduced by liabilities) of the subsidiary company. On
the other hand, consolidated method id used when a parent company owns at least 50.1%
share of its subsidiary. About consolidating financial statements, intra-company transactions
refer to transactions that occur between different companies, which are a part of the same
group. These should not be included in the financial statements at the time of consolidation.
Non-controlling interests’ disclosure guidelines suggest that these items should be presented
separately to avoid manipulating the stakeholders of an entity.
Response to Part A
As per the recommendations of AASB 3, the need to improve the transparency,
efficiency, inter-comparability and clarity of the information provided by an organization in its
consolidated financial statements is more than ever before (AASB and CAS 2014).
Accounting methods like consolidation method and equity accounting method are very
popular in preparing the consolidated financial statements (Milojevic, Vukoje and Mihajlovic
2013). However, to be able to obtain a reasonable level of understanding of the functioning of
both these methods, an understanding of the terms that are to be satisfied to apply these
methods, is necessary.
The usage of equity accounting happens when an investor is said to have a key
influence in his investee’s decision-making procedures (Grossi et al. 2013). According to the
5th paragraph in AASB 128, a holding company or otherwise is understood to have a
significant influence in another company if they have a share of at least 20% of the voting
power in the company by stock holding or any other manner. The significant influence can
end at any point of time due to reasons like modifications in capital structure, intervention of
the government or sale of the rights to another party. Using this method, recognition of the
investment first takes place at cost and the difference in balance is modified to present the
profit or loss of the investor in the investment. These modifications take place due to factors
like revaluating the assets; amount paid by investee to investor or because of fluctuations in
foreign currency rates.
For an instance, an entity P obtains 40% share of another organisation D for $2500.
This makes company P an investor and indicates that P possesses a significant influence in
the matters of company D. The entry necessary to present this transaction in books of
accounts is as below:
Following this scenario, company D declares a quarterly income worth $1500 in addition to an
amount of dividend of $200. Either of these scenarios inflate P’s investment value and should
be accounted by:

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
In order to use consolidation accounting, there is a need to determine the share of the holding
company in the subsidiary. If the holding entity has a bulk part i.e. a share greater than 50.1%
of the subsidiary, then this method is used for consolidation (Smith and Smith 2014). Owing
the majority share is popularly known as enjoying effective control. While using this manner,
the holding company statuses its investment of the subsidiary in the form of an asset while its
subsidiary states it as equity in its own books. At the time of consolidating the financial
statements, an alteration entry has to be approved to remove the effects of any intra-group
transactions to avoid the misstatement of profits.
For example, a company H obtains the total share in a subsidiary for a consideration of $30
million. This is to be presented in the books of the holding company in the following manner:
Whereas, in its subsidiary’s books of accounts, a similar deal is to be chronicled in the
following way:
During the end of the financial year, an adjustment entry has to be done to remove deficit in
the cash balance in the books of Company K. Likewise; an alteration entry should also be
approved to not overstate the equity of the whole entity. These entries are necessary to make
sure that the financial information provided by the consolidated financial statements measures
the economic performance of the unit in an accurate manner.
Response to Part B
According to rules stated in AASB 127’s 4th paragraph, the purpose of consolidated
statements is recording the worth of assets, liabilities besides obligations of a holding
company and its subsidiaries as ones that belong to a single entity (www.aasb.gov.au 2019).
While AASB 10’s paragraph B86 suggests that for confirming the appropriate consolidation of
financial statements, incomes, properties, obligations as well as losses occurring from
transactions between the companies of the same group should be eliminated completely from
the books (AASB and CAS 2016). The primary improvement of this technique is that this
avoids the duplication of entries and hence provides a correct estimate of the profit for a given
financial year. In the situation of JKY Ltd., the loss or income on the transaction of inventory
with a subsidiary to its parent company should not be recognized as a decrease in the cash
balance of the parent firm as the benefit of possessing the stock is eventually attained by the
entity. As for the services that the secondary company provides to its parent business,

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
recording the same as an expense should be avoided as both the cost of the service and its
benefit belong to the whole entity (Beuselinck and Deloof 2014).
AASB 10’s rules suggest that non-controlling interest (NCI) is understood to be that
part of the segment of the subsidiary firm which does not belong to its parent concern neither
directly nor indirectly. In order to calculate the NCI of an establishment for a specified financial
year, all kinds of intra-company dealings have to be detached completely and there is no part
that the proportion of the holding or subsidiary business plays. Although, while distributing the
dividends, their distribution takes place in accordance with the portion of the parent company
in its subsidiary without using any other manner (Presentation of Financial Statements, 2016).
In case of JKY Ltd., NCI should be calculated by deducting the gains on the sale of stock and
the consideration for the facilities delivered by its subsidiary completely.
A case in which an entity P Ltd. has 80% part of the value of the stock of a subsidiary
firm S. P Ltd. trades stock worth $60,000 with S Ltd. at $80,000. At the ending date of
financial year, S Ltd. possesses around 50% of these goods as a part of its inventory. This
stock contained by S contains an unrealised profit valuing $20,000. The aspect of profit which
is not realised should not be presented in the accounts’ books- irrespective of the NCI that
occurs between either of the companies (Rahman, Moniruzzaman and Sharif 2013).
Therefore, when consolidating the financial statements, the entries essential to remove the
results of these internal transactions are as mentioned below:
Another internal transaction, which arises on an extremely consistent basis, is related
to the aspect of dividend given by a parent company to its subsidiary firm. For instance, a
parent company pays $300 dividend to the subsidiary where it has a share of 100% i.e. it fully
owns the company. The amount of dividend is to be considered as a part of the revenue by
the subsidiary. The source of payment of the dividend, i.e. equity before acquisition or the
equity after acquisition is not relevant in this case (Gajewski 2013). The entries required for
these kinds of transactions are accordingly:

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
Other probable situations when intra-group transactions happen and is to be
accounted for in the financial statements during consolidation are intra-group borrowings and
intra-company debentures. A company derives a sum of $6000 with a twelve-monthly interest
of 7% from an entity part of its set. The following journal records should be recorded for
removing the intra-group dealings out of the consolidated financial statements:

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
Response to part 3
As per AASB 127’s 27th paragraph, “non-controlling interests should be presented in
the consolidated statement of financial position within equity, separately from the equity of the
owners of the parent company” (www.aasb.gov 2016). The major reason behind the change
in the regulations which suggest that NCIs should be presented distinctly using the
consolidated statements is for providing details about control of the NCI with respect to the
operating activities and the cash flows of the group as a whole (Vazek and Gluzova 2014).
Apart from this, disclosing the value of NCIs provides the stakeholders with details about
aspects like control and extent of restrictions on the usage of assets, obligations about the
payment of liabilities and the structure of the group. It also provides knowledge about the risk
of dropping control in the title or the management of the concern and any situations that need
to be evaluated to assess the losses or benefits that may occur. The major advantage of
having the disclosure of NCIs is that they keep all the stakeholders aware about the changes
occurring in the organization and the results such changes may bring within the organization
(Ramadhan 2014).
Every organization, including its subsidiaries, should disclose the amount of control
that the NCIs have in the decision-making hierarchy and the operational aspects of the entire
business. The information that needs to be presented is inclusive of aspects like name, nature
of business, place where the operations take place, proportion of ownership of NCIs in the
entity, alterations in voting controls and the shares possessed by the NCIs and reasons for
such differences with regard to NCIs. The accumulated capital that the NCIs own in the
organization over the years should also be mentioned to ensure transparency in the
organization (Hansmann and Kraakman 2017).
With respect to the situation of JKY Ltd., the major task to be taken care of before
consolidation is the distribution of comprehensive profit to the non-controlling interests. AASB

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
101 also suggests that irrespective of the possibility that NCI could deal with undesirable
balances in their accounts’ books, comprehensive profit has to be appropriately apportioned
between the parent company’s owners as well as the NCIs of the entity. Since it is mentioned
that the subsidiary registers its assets using the method of historic costing, depreciation or the
amount of amortization should be deducted correctly before arriving at the amount of
comprehensive profit earned in a given financial year. Comprehensive income is slightly
different from comprehensive profit in the sense that it is allocated to both the subsidiary and
the owners of the parent in accordance with their shares in its subsidiary enterprise (Bratten,
Causholli and Khan 2016).
In case of any changes in a share held by the NCIs in a subsidiary company, the same
should be specified in the financial reports to reflect changes in capital structure of the
organization. This is to benefit the stakeholders with an understanding of the probable change
in benefits, which may occur. This is to be treated by computing the alteration between the
additional portion obtained by the NCI and the amount paid by them for obtaining such share.
The difference becomes the income of the holding company’s owners (Cordazzo 2013).
In cases where a parent company loses control of the subsidiary to the NCIs, it should
stop recognizing the assets and obligations of that entity on the date when control of such
kind ceases to exist, in addition to its interests in the previous subsidiaries (Ioannou and
Serafeim 2017). Any amount that it receives as a part of the compensation for losing the
control is to be recognized in its books of accounts by the subsidiary company. The remaining
amount of the investment in the subsidiary should also be clearly stated.
Issues from Consolidation Process
Although consolidation intends to increase the transparency with which a business is to
be conducted, its reliability becomes questionable in many practical situations. In the modern
day business scenario, every major corporation has a large number of subsidiaries operating
under it. Determining and mentioning the amount of NCI in every subsidiary’s case becomes
tedious and pointless after a certain time. This also leads to the wastage of time and
capabilities of the personnel. The lack of exact application of the procedures at the time of
consolidation makes the information provided by the consolidated financial statements
redundant (Allen, Gu and Kowalewski 2013). Bogus firms are a major cause of obtaining tax
benefits and manipulating profits for most of the major companies. Enron is the biggest
example of the disadvantages of having a large number of subsidiaries.
Conclusion
From the above discussion, it can be concluded that consolidated and equity
accounting have their own set of benefits and disadvantages. They should be applied
according to the limitations mentioned by the guidelines of AASB to get effective results at the
time of consolidation. Benefits or damages incurred from intra-group transactions have to be
exempted from being a part of the consolidated statements as they lead to the statement of
misleading profits and losses because of passing the same entries twice in the books. In
previous years, there was never enough emphasis on statement of NCIs. The change in this
scenario is expected to cause an improvement in the quality required in the presentation of
consolidated financial statements.

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CORPORATE TAKEOVER DECISION MAKING AND THE EFFECTS ON
CONSOLIDATION ACCOUNTING
References
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