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Author's profile photo Patricia METEIL-DUTARTRE

How starter kits meet IFRS – IAS 27 (part 2)

This series of blogs describes how SAP® BusinessObjectsTM Financial Consolidation, Starter Kit for IFRS has been configured to meet International Financial Reporting Standards (IFRS).

In our previous blogs, we have covered the following topics:

In this blog, we will carry on our analysis of IAS 27 with a focus on the changes in the consolidation scope.

The recent revision of IFRS 3 and IAS 27 (Business Combinations II) has brought many changes in the way consolidation scope changes should be accounted for.  The key principle is that only a change in control – but every change in control – is a significant event.  Changes in control means: obtaining control over an entity or losing control of an entity. Once control has been achieved, any subsequent transactions that do not result in a loss of control are accounted for as equity transactions.

Loss of control and equity transactions are under the scope of IAS 27 whereas business combinations are covered by IFRS 3 (see How starter kits meet IFRS – IFRS 3). In this blog, we will focus on how to handle a loss of control.

Accounting principles

The loss of control of a subsidiary results in recognizing a gain or loss in the income statement. When the parent company loses control but retains an interest, it triggers recognition of gain or loss on the entire interest:

  • a gain or loss is recognized on the portion that has been disposed of;
  • a further gain is recognized on the interest retained, being the difference between the fair value of the interest and its book value.

Both are recognized in the income statement.

For example, if a parent company sells 80% of its former wholly-owned subsidiary S, retaining a 20% interest, gain or loss will be calculated as if the 100% interest has been sold:

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When a parent loses control of a subsidiary, the parent should account for all amounts previously recognized in Other Comprehensive Income (OCI) in relation to that subsidiary on the same basis as would be required if the parent has directly disposed of the related assets or liabilities.

Therefore, if a gain or loss previously recognized in OCI would be reclassified to profit or loss on the disposal of the related assets or liabilities, the parent reclassifies the gain or loss from equity to profit or loss (as a reclassification adjustment) when it loses control of the subsidiary .

This “recycling process” applies to fair value reserve, hedging reserve and foreign currency translation reserve.

If the residual interest in the former subsidiary gives a significant influence or a joint control, the acquisition method is applied to this residual interest as if a new associate or joint-venture has been acquired.

In the starter kit

In SAP BusinessObjects Financial Consolidation, loss of control can result:

  • in an entity leaving the scope (when the parent company does not keep any interest or when the remaining interest is under the consolidation threshold)
  • in a change in consolidation method (subsidiary becoming an associate)
  • in a change in consolidation rate (subsidiary becoming a joint-venture)
Outgoing entities

In the consolidation scope, outgoing entities are identified as “outgoing at the opening” or “outgoing during the period” depending on whether data are entered or not for the period. Data entered, if any, must correspond to the period lasting from the beginning of the year to the date when control is lost so that income and expenses of the subsidiary are included in the financial statements until the date when the parent ceases to control the subsidiary (as required by IAS 27).

All of the outgoing company’s data at the date of the disposal is automatically reversed on a dedicated flow (F98). For accumulated OCI that has to be recycled, this flow is regarded as a reclassification adjustment in the statement of comprehensive income.

After gain or loss on disposal has been calculated, a manual journal entry has to be booked to adjust the gain or loss recognized in the parent’s separate financial statements.  

Changes in the consolidation method

In SAP BusinessObjects Financial consolidation, changes in consolidation method are handled as follows:

  • Opening balances are reversed on the “old method” flow (F02)
  • Opening balances are reloaded on the “new method” flow (F03) with the new consolidation method applying

As regards a change from full consolidation to equity method, it means that:

  • the subsidiary’s assets and liabilities are reversed and “replaced” by the line “Investments in associates”
  • the equity accounts are reversed on the old method flow and reloaded on the new method flow taking into account the consolidation rate of the associate; allocation between group and indirect non-controlling interests (if any) is made on this flow according to the new interest rate

Any goodwill existing at opening is not reloaded on the new method flow. Indeed, it is part of the assets sold and is, therefore, taken into account to calculate the profit on “disposal”. A new goodwill has to be calculated as part of the acquisition method process of the associate and declared by a manual journal entry using the new method flow.

Accumulated OCI at opening is automatically reclassified to retained earnings on the new method flow like for incoming entities. Reclassification adjustments displayed in the comprehensive income take into account the old method flow because change in consolidation method is handled as if the subsidiary was disposed of.

Manual journal entries are necessary to:

  • adjust the gain or loss recognized in the parent’s separate financial statements on the interest sold
  • recognize a gain or loss on the remeasurement of the interest retained at fair value
  • remeasure net identifiable assets of the new associate to fair value (as if it was an incoming entity)
  • declare goodwill.
Change in the consolidation rate (subsidiary becoming a joint-venture)

In SAP BusinessObjects Financial Consolidation, the impact of the change in consolidation rate (from 100 % to x% in this case) is posted on a dedicated flow (F04).

Manual journal entries are similar to those explained above for a subsidiary becoming a joint-venture. However, as a change in consolidation rate – even when it results in a change in method from full to proportionate consolidation – is not regarded as a change in scope by the consolidation engine, additional manual journal entries may be necessary. In particular, recycling OCI is not made automatically.

What’s next ?

In the How starter kits meet IFRS – IAS 27 (part 3), we will focus on equity transactions.

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      10 Comments
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      Author's profile photo Sreekanth E
      Sreekanth E
      Hi Patrica,

      In case if we have to apportion the entire 100% profits / loss, what happens to the group and MI share in Income Statemnet which was already apportioned during Subsequent consolidations? I guess subsequent consolidations are not treated as equity transactions.

      Thanks
      Sreekanth

      Author's profile photo Patricia METEIL-DUTARTRE
      Patricia METEIL-DUTARTRE
      Blog Post Author
      Hi Sreekanth,
      Sorry, I’m not sure that I’ve fully understood your question. Do you refer to the calculation of gain or loss on divestiture in a subsidiary which is not fully-owned or do you refer to the treatment of accumulated earnings in case of an equity transaction ?
      I look forward to hearing from you soon
      Kind regards,
      Patricia
      Author's profile photo Sreekanth E
      Sreekanth E
      Thanks Patricia for reply. Let me reframe my question:
      My question partly relates to the first question you have pointed out in your message. In course of business, subsidiary's profits / loss (Retained earnings) are apportioned to parent and Minority interests. This is reflected in Income statement and balance sheet. What happens to these postings in case of total divestiture?
      Hopefully this clarifies my question.

      Thanks
      Sreekanth

      Author's profile photo Patricia METEIL-DUTARTRE
      Patricia METEIL-DUTARTRE
      Blog Post Author
      Hi Sreekanth,

      In Financial Consolidation, the adjustment to the gain or loss on divestiture (as booked in local accounts/ being the difference between proceeds of sale and booking value of shares in the holding company) is not made automatically but has to be entered by a manual journal entry. I know few about SEM-BCS but I have been told that this adjustment is automatically booked and corresponds to the reversal of accumulated reserves since acquisition.
      In Financial Consolidation, the adjustment is booked by manual journal entry at the investor level (means: in the entity that held the shares and sold them). It shall correspond to the investor’s share in accumulated reserves. It means that direct minority interest’s shares in accumulated earnings are not reversed through P&L. They are derecognized from the balance sheet and presented in the statement of changes in equity as a movement of the period. This is because the gain or loss on corresponding shares (those held by minority interest) is not included in the P&L (these shares have not be sold); therefore no adjustment is needed.
      I hope my answer is clear but this treatment is quite difficult to explain in few words …
      Please don’t hesitate if you need more details
      Kind regards,
      Patricia 

      Author's profile photo Sreekanth E
      Sreekanth E
      Hi Patricia,

      I am still not clear about the treatment of profit / loss relating to NCI / MI share postings in Income statement. Suppose parent company jolds 80% in subsidiary and 20 % by NCI / MI. In period 3, subsidiary reported 100 profit. 20% of these profits have been assigned to NCI / MI in Income statement and corresponding entry in balance sheet also. And in Period 6, parent divests the entire 80% holding in subsidiary. In such a case, what is the treatment for 20% NCI / MI profits? Does these postings need to be reversed?

      Note - If you can share me your emailid, I can probably mail you my workings for better understanding.

      Thanks
      Sreekanth

      Author's profile photo Patricia METEIL-DUTARTRE
      Patricia METEIL-DUTARTRE
      Blog Post Author
      Hi Sreekanth,

      The 2O% NCI profits previously recognized need not to be reversed. The reversal is made only for the parent company’s share because it represents the difference between the gain or loss on divestiture in the parent company’s separate income statement and the gain or loss that should be reported in the group’s consolidated statement.
      To go on with your example, we suppose that the parent company has subscribed to the initial issuance of the subsidiary with 80% of shares (investment = 80)
      Net profit in period 3 affects cash (to keep it simple) so that the subsidiary’s balance sheet at the date of divestiture is:
           Cash 200 (DR)
           Capital 100 (CR)
           Retained earnings 100 (CR)
      In period 6, the parent company sells its investment for 200.

      As explained in paragraph 34 of IAS 27, the gain or loss will be calculated as follows:
           Debit     Credit
      Derecognition of subsidiary’ assets and liabilities            200CR

      Derecognition of the carrying amount of NCI       40DR
      (=20% x 200)
      Fair value of consideration received (sales price)      200DR     
      Gain or loss on divestiture (difference)            40CR

      => In consolidated statements, the gain on divestiture is 40.     
      In the parent company’s separate statement the gain on divestiture is 120 (=200 – 80).
      The adjustment to be posted (- 80) corresponds to the reversal of the parent company’s share in post-acquisition profits of the subsidiary (profit of 100 in period 3 at 80%)
      Regarding derecognition of NCI (40 including 20 of I/S postings in period 3), IAS 27 does not give any guidance. In the examples I’ve seen so far (whether by clients or in literature on this topic), this derecognition is accounted for as a movement in equity and doesn’t affect the income statement.

      My email is patricia.meteil-dutartre@sap.com. However, if possible, I would prefer to continue our discussions in this blog so that other readers can benefit from them.   

      Kind regards,
      Patricia 

      Author's profile photo Sreekanth E
      Sreekanth E
      Thanks Patricia for your reply.

      Should the gain/loss on account of divestiture belonging to NCI/MI be reported in Income Statement?

      Thanks
      Sreekanth

      Author's profile photo Patricia METEIL-DUTARTRE
      Patricia METEIL-DUTARTRE
      Blog Post Author
      The gain/ loss on divestiture is attributable to the parent company only. In our example, there is no gain or loss on divestiture for NCI. I/S postings of prior periods re: NCI are derecognised from the balance sheet but this reversal is not reported in income statement.
      Kind regards,
      Patricia
      Author's profile photo Sreekanth E
      Sreekanth E
      Hi Patricia,

      What in case if we have any gain/loss on divestiture for NCI? Will this be reported in Income statement?

      In the current BCS system, we maintain seperate P&L account for Gain/loss on divestiture for NCI.

      Thanks
      Sreekanth

      Author's profile photo Patricia METEIL-DUTARTRE
      Patricia METEIL-DUTARTRE
      Blog Post Author
      Hi Sreekanth,

      Given that the adjustment of the gain / loss on divestiture is made by manual journal entry in the starter kit, you can enter an amount of gain / loss attributable to NCI if need be.
      Regards,
      Patricia