CONSOLIDATION EXEMPTION FOR A PARENT COMPANY

There are certain situations in which a parent company may not wish to consolidate a subsidiary. In this article, we are going to discuss why a parent company may wish to do so, and the circumstances in which the non-consolidation of subsidiaries is permitted by International Accounting Standards.

There are two common arguments by companies who may not wish to consolidate their subsidiaries, i.e.:

• to improve the reported financial position and performance of the group financial statements; and
• where consolidating a subsidiary might not give a fair presentation of the performance and position of the group.

Let's look at these arguments in more detail.

Improvement of financial position and performance

The financial statements of a subsidiary could show poor financial position and performance, such as substantial operating losses, poor liquidity position, high levels of borrowings (high gearing), etc. Thus, if a parent company was to consolidate such a subsidiary, then it would proportionately worsen the group position and performance in the above areas. Thus, a parent may prefer not to consolidate poorly performing subsidiaries.

It is apparent that these reasons for non-consolidation are not permitted by International Accounting Standards. A parent company cannot simply 'hide' one of it's subsidiaries due to the poor performance and position of the entity.

Fair presentation

The argument here is due to two reasons as follows:

1. The subsidiary operates under severe long-term restrictions. In effect, the parent does not have full control (particularly over the ability to transfer funds to the parent) over the subsidiary.
2. Control is only intended to be temporary because the subsidiary is held exclusively with a view to its subsequent resale.

In theory, these reasons for non-consolidation might in fact be justified. However, the International Accounting Standards Board (IASB) has dealt with these issues in its own ways.

The revised IAS 27 Consolidated and separate financial statements do not allow any exclusions from consolidation. This means that all subsidiaries must be consolidated. However, IAS 27 requires the disclosure of the nature and extent of any significant restrictions on the ability of a subsidiary to transfer funds to a parent.

Where a subsidiary is held exclusively with a view to its subsequent resale (and provided that it has not previously been consolidated), IFRS 5 Non-current assets held for sale and discontinued operations requires that it is presented separately in the statement of financial position and that other information is disclosed so that users of the financial statements are made aware that control is only intended to be temporary.

In addition, companies may sometimes be excluded on the basis of differing activities. Companies that have adopted this approach argue that to add together the assets and liabilities of companies whose activities differ greatly might lead to consolidated financial statements that are misleading. IAS 27 has never permitted exclusion on these grounds because it feels that 'differing activity' problems are overcome by the provision of segmental information under IFRS 8 Operating segments.

It can be seen from above that those arguments for not consolidating subsidiaries are not allowed by International Accounting Standards. The circumstances in which a group may claim an exemption from the preparation of consolidated financial statements are very limited.

A parent need not present consolidated financial statements if and only if all of the following are fulfilled:

1. The parent is itself a wholly-owned or partially-owned subsidiary of another entity, and its other owners (including those who are not entitled to vote) have been informed about, and do not object to, the parent not presenting consolidated financial statements;
2. Its securities are not publicly traded;
3. It is not in the process of issuing securities in public security markets; and
4. The ultimate or intermediate parent publishes consolidated financial statements that comply with International Financial Reporting Standards.