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New paradigm for consolidated financial statements

Dolphy D?Souza | Updated on January 27, 2013 Published on January 27, 2013

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Dolphy D’Souza is Partner in a member firm of Ernst & Young Global

Companies preparing consolidated financial statements on IFRS basis alone will now haveto prepare them based on Indian GAAP.

Currently, under the listing agreement, listed companies have to prepare consolidated financial statements. Neither the existing Companies Act nor AS-21 asks for this. Companies Bill mandates it for all companies, including non-listed and private companies that have a subsidiary.

Unlike IAS-27, Companies Bill does not exempt an intermediate non-listed parent from preparing consolidated financial statements. IAS-27 exempts a non-listed intermediate parent if

it is a wholly-owned subsidiary, or a partially-owned subsidiary of another entity, and its other owners do not object to the parent not presenting a consolidated financial statement; and

any parent company above it produces a consolidated financial statement that is available for public use.

Preparation of consolidated financial statements at each intermediate parent level is likely to increase compliance cost. However, from a regulator’s perspective, it will help monitor groups more effectively.

For all companies, a consolidated financial statement should comply with notified accounting standards, which currently means Indian GAAP. In future, this may include Ind-AS for specified entities. This will impact companies that are currently preparing the statements only according to IFRS (International Financial Reporting Standards), under the listing agreement.

There is some confusion regarding associates and joint ventures. The explanation to the section states that “the word subsidiary includes associate company and joint venture”. The following two arguments seem possible:

A company needs to consolidate associates and joint ventures in accordance with the notified AS using equity/ proportionate consolidation method. In other words, consolidated financial statement is prepared only when the group has at least one subsidiary.

A company needs to apply equity method/ proportionate consolidation to its associates and joint ventures even if it does not have any subsidiary. In other words, consolidated financial statement will be prepared when the company has an associate or joint venture even when it has no subsidiary.

The first view seems more aligned to the notified AS. The second view can be supported if the lawmaker’s intention was to make a company apply equity method/ proportionate consolidation method to its associates and joint ventures even if it does not have any subsidiary. The Institute of Chartered Accountants of India and the Ministry of Corporate Affairs should clarify on this.

AS-21 defines “control” as “(a) The ownership, directly or indirectly through subsidiary(ies), of more than one-half of the voting power of an enterprise, or (b) Control of the composition of the board of directors so as to obtain economic benefits from its activities.” It defines subsidiary as “an enterprise that is controlled by another enterprise”.

Companies Bill defines it as “Subsidiary company or subsidiary, in relation to any other company (that is to say, the holding company), means a company in which the holding company: (i) Controls the composition of the board of directors, or (ii) Exercises or controls more than one-half of the total share capital either on its own or together with one or more of its subsidiary companies.” Moreover, “Control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.”

The definition of “control” in Companies Bill is broader than the notion of “control” envisaged in the definition of “subsidiary”, where only board control and control over share capital are considered. However, the definition of “control” suggests that a company may control another company through other mechanisms also — say, management rights or voting agreements. This raises the question whether a company should consider the definition of “control” in identifying subsidiaries for consolidation and other purposes. Further, the definition of “subsidiary” refers to control over more than one-half of total share capital, without differentiating between voting and non-voting shares. This could lead to a situation where a company is a subsidiary under AS-21, but on which the parent has no control as defined in the bill, and so on.

There is a similar confusion regarding associates. Under the Bill, the term “significant influence” means control over 20 per cent of business decisions. Control over business decisions is an indicator of subsidiary, rather than associate. It appears that the definition in the Bill “controls 20 per cent of business decisions” is wrongly described.

The right way would have been “has significant influence over all critical business decisions” and “significant influence is evidenced by 20 per cent voting power, representation on the board, or through other means.”

The Corporate Affairs Ministry may clarify that the definitions in the Bill are relevant for legal/ regulatory purposes. For accounting purposes, including preparation of consolidated financial statements, definitions according to the notified AS should be used.

Dolphy D’Souza is Partner in a member firm of Ernst & Young Global

Published on January 27, 2013
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