Consolidated Financial Statements & CONTROL

1.1 Meaning of Consolidated Financial Statements

Consolidated Financial Statements (CFS) are the financial statements of a group presented as those of single economic entity. A group is a parent and all its subsidiaries. A parent is an investor that controls another entity called subsidiary. The parent and subsidiary (ies) constitute a Group.

A parent company is required to prepare CFS of the Group as a whole. CFS are:

1. Consolidated Balance Sheet

2. Consolidated Comprehensive Income Statement

3. Consolidated Statement of Changes in Equity

4. Consolidated Statement of Cash Flows

5. Notes and other statements

6. Statement of Restatement Analysis

1.2 Meaning of Control

Control: is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

Criteria in deciding control over another entity are:

i. Majority voting power (more than half of the voting rights);

ii. Power to govern financial and operating policies of the entity under a statute or agreement;

iii. Power to remove majority of the board members and control of the entity is by that board;

iv. Power to cast majority votes at board meetings.

1.2.1 Potential voting rights: Financial instruments which are convertible into equity shares with voting rights are termed as instruments having potential voting rights. Examples are share warrants, convertible debentures, convertible preference shares, etc. While evaluating control the potential voting rights are taken into account. However, it is necessary to take into account all facts and circumstances including terms of exercise and other agreements before counting such potential voting rights.

Example 1.1 Planet Ltd. holds 45% stake in IStaR Ltd. out of the 20 million equity shares of the investee company. In addition, it holds 20 million out of the 30 million share warrants issued by the company. Does Planet Ltd. control IStaR Ltd.?

Solution 1.1 Total voting rights of IStaR Ltd.:

Current 20 million

Potential 30 million

Total 50 million

Out of which Planet Ltd. holds.:

Current 9 million

Potential 20 million

Total 29 million

So Planet Ltd. holds majority voting right of IStaR Ltd. on the basis of current and potential voting rights. IStaR Ltd. is a subsidiary of Planet Ltd.

It is not relevant to analyze whether the Planet Ltd. intends to exercise the warrants or it has the financial ability to exercise the warrants. Only issue evaluated is whether it has ‘authority’ to exercise the warrants.

Even ‘out-of-money call option’ held by the investor is counted as potential shares despite the fact that the options are currently worthless. The issue is the right to exercise not that whether the entity will exercise or not.

1.2.2 Dual control and issue of consolidation: Dual control may occur in rare situation when an entity establishes control through majority voting rights but another company has appointed majority Board members. In this case both the entities which have control should consolidate.