Accounting for Investments

A group is a cohesive economic unit. And, a cohesive economic unit is one that is subject to control from a common source. We can look at a group of companies as being made up of a number of separate legal entities that are subject to common control and therefore can be said to be a single economic entity for financial reporting purposes.

Within a group there is a parent company. It is the parent company, which usually exercises common control. The exercise of common control means that the parent entity controls the operating and financial policies of the other entities of the group, which are known as the subsidiary entities.

A subsidiary is an entity that is controlled by another entity. In financial management, control is known as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. And, the  most common way for one entity to control another is by obtaining a sufficient number of equity shares to control more than 50% of the votes at shareholders' meetings.

The obligations of a parent company are that it should prepare consolidated statements, in addition to its own separate accounts (according to IAS 27, Consolidated and Separate Financial Statements). The following are the consolidated statements a parent company is expected to prepare: A consolidated statement of financial position dealing with the state of affairs of the parent and all of its subsidiary entities; A consolidated income statement dealing with the profit or loss of the parent and all of its subsidiary entities; A consolidated statement of cash flows dealing with the cash flows of the parent and all of its subsidiary entities.

In addition, there are further guidelines on when a parent company could prepare consolidate financial statements, such as the following: The parent entity's debt or equity instruments are traded on a public market; The parent is engaged in filing statements in preparation for trading in a public market.

However, a parent entity is not required to prepare and present consolidated financial statements if: It is specifically exempted by the IAS from doing so. The parent entity has itself an ultimate or immediate parent that prepares and presents consolidated financial statements for public use; Where a subsidiary has been acquired and is held exclusively with a view to its subsequent disposal (within 12 months of the year end), it does not require consolidation. It is treated as an asset 'held for sale' (as per IFRS 5).

Associate companies are dealt with through IAS28. This standard defines an associate as an entity, including an unincorporated entity such as a partnership, over which the investor has significant influence and that is neither a subsidiary nor an interest in a joint venture. According to IAS 28, significant influence is the power to participate in the financial and operating policy decisions of the entity but is not control over those policies.

The existence of significant influence by an investor is usually evidenced in one or more of the following ways: Representation on the board of directors; Participation in policy-making processes; Material transactions between the investor and the entity; Interchange of managerial personnel; Provision of essential technical information; A holding of at least 20% creates a presumption that the investor exercises significant influence, unless it can be demonstrated that this is not the case.