Dundalk Centre Accounting for Groups

Summary Type Group Description Control:- by contract or % owned (This used to be 51% but can now be by contract or "FRS 5"). "Veto" by any party "influence" (can appoint director) No influence (even if 51%+ holding) No cash leaves the group on merging + other rules. Accounting Group consolidated financial statements - 6 step method goodwill arises As per associate but double the disclosures Cost + group share of post acquisition profits in associate. Cost plus dividends received Add everything - difference to reserves

Joint venture Associate Investment Merger

Group accounts - Balance sheet consolidation 6 step approach 1. Do the graph of the ownership structure 2. Calculate goodwill: the difference between what you paid and what you got (use the market or fair value to calculate what you got) at the time of the purchase. 3. Minority interest is the minorities share of the assets and liabilities at the balance sheet date 4. Retained earnings is the holding company retained earnings plus the groups share of the post acquisition retained earnings of subsidiary. 5. Share capital is the share capital of the holding company 6. Add everything together (netting off contra items). Extra bits I/C Loans: Dividends:

net off on consolidation only the dividend attributable to minority part of a subsidiary dividend or the whole holding company dividend will appear on consolidation Acquisition during year: reserves split as to pre and post (time apportioned) acquisition Pre acq. Losses: Group still gets its share of post acq. profits in subsidiary so careful calculation needed FRS 7 Value all assets in the subsidiary at market value (fair value) at the date of acquisition for consolidation purposes.

I/C trading

eliminate all profits on inter-company trading - only external to the group profits should be included. Minority interest is adjusted for their share of adjustment. Profit is earned by the seller. Eliminate minority % of profit as well as holding company. Sale of fixed asset - eliminate all profit or loss on sale and additional depreciation. Minority interest is adjusted for their share of adjustment. Goodwill In the absence of instructions to the contrary, goodwill arising on consolidation should be amortised to the profit and loss account on a systematic basis over a period of 20 years. Rules of Thumb i Unless told to the contrary, assume that profits accrue evenly throughout the year. ii As dividends are paid out of profits assume they also accrue evenly throughout the year. iii Always ensure that we have made the necessary fair value adjustments to the net assets of the subsidiary(ies) at the date of acquisition for consolidation purposes. Iv Always consider the requirement to make adjustments on consolidation for inter company trading and inter company disposal of capital assets.

Consolidated Profit and Loss Account Add everything together down to "profit after taxation" Deduct minority interest (it is the minority share of after taxation profits) B/f retained profit is holding company retained profits plus group share of post acquisition profits in subsidiary.

Adjustments required: (i) Always adjust for inter group trading as between turnover and cost of sales. < Eliminate > (ii) Any unrealised profit element contained in stocks as a result of (I) above should be provided for. Per FRS 2: The key question to ask is who has sold the goods as this determines where the provision for unrealised profit is to be made.

Minority interest and preference dividend:- get the minority % of the preference dividend and add the minority share of the residual profits (after the full preference dividend). With acquisitions during the year, time apportion the profit and loss for the subsidiary and then consolidate as normal. The Standards in Detail

FRS 2: Accounting for Subsidiary Undertakings: The FRS sets out the conditions and the manner in which a subsidiary and its parent should prepare consolidated financial statements. Parent and Subsidiary: A company is the parent of another (a subsidiary) if any of the following apply: I It holds a majority of the voting rights. II It is a member of the subsidiary and has the right to appoint or remove directors holding a majority of the voting rights. III It has the right to exercise a dominant influence over the subsidiary. (a) By virtue of provisions contained in the subsidiaries memorandum or articles; or (b) By virtue of a control contract. IV It is a member of the subsidiary and controls alone, a majority of the voting rights in the undertaking. V It has a participating interest in the subsidiary and: (a) It actually exercises a dominant influence over the subsidiary; or (b) It and the subsidiary are managed on a unified basis. VI A parent is also treated as the parent of the subsidiary of its subsidiary. Exemption from Preparations of Consolidated Accounts: (1) The parent is a wholly / majority owned subsidiary of a European community company. (2) The parents subsidiaries are permitted or required to be excluded from consolidation. (3) They are exempt under the European Communities (Companies: Group Accounts) Regulations 1992 on the basis of size.

"the parent undertaking and all of its subsidiary undertakings together, on the basis of their latest annual accounts satisfy two of the following three qualifying conditions : (a) the balance sheet total of the parent undertaking and its subsidiary undertakings together does not exceed 6,000,000, (b) the amount of the turnover of the parent undertaking and its subsidiary undertakings together does not exceed 12,000,000, and (c) the average number of persons employed by the parent undertaking and its subsidiary undertakings together does not exceed 250." Exclusion from consolidation summary of requirements FRS 2 Company's Acts Severe long term restriction "should be excluded" May be excluded Held for subsequent resale (and "should be excluded" May be excluded not previously consolidated) Different activities Will almost never happen, but if May be excluded it does - exclude. Cost or time May not exclude May exclude Exclusion and Treatment of Excluded Subsidiaries: Required Exclusion: Severe long term restrictions hinder the exercise of control by the parent Treatment: Treat as a fixed asset investment valued using the equity method of accounting at the date the restrictions came into effect (i.e. group share of net assets plus goodwill). If group exercises significant influence it should be treated as an associate. The value should be regularly reviewed and written down to reflect any permanent diminuity in value. The subsidiary should be recorded in the consolidated financial statements at the lower of cost and net realisable value.

(1)

(2)

(3)

The interest in the subsidiary is held exclusively with a view to subsequent resale and the subsidiary has not previously been consolidated. The subsidiarys activities Record

in

consolidated

accounts

are so different from using the equity method of accounting those of other (i.e. the same as an associate). subsidiarys that inclusion would not give a true and fair view (very rare, does not arise just because companies are in different businesses i.e. industrial or services). Minority Interest (Part of subsidiary NOT owned by the group): The consolidated balance sheet should show the minority share of the capital and reserves as minority interest. The consolidated P&L should show separately the minority share of the profit or loss on ordinary activities. Profits or losses in a subsidiary should be shared between the parent and the minority in proportion to their respective holdings. The assets and liabilities attributable to the minority should be included on the same basis as those attributes to the group (i.e. fair values). No goodwill should be attributed to the minority. Intra Group Transactions: Unrealised profit or losses on any intra group transactions should be eliminated in full. Where the unrealised profit is in a subsidiary it should be eliminated against the group and the minority in proportion to their holdings. Intra group debtors and creditors should also be cancelled. If a subsidiary is excluded from consolidation because of different activities unrealised profits should also be eliminated. Accounting Policies: Uniform accounting policies should be used throughout the group and if necessary adjustments should be made to the amounts which have been reported by the subsidiaries in their individual accounts. In exceptional circumstances different policies may be used - details must be disclosed.

Accounting Dates and Periods:

Accounts of all subsidiaries should be prepared to the same year end and for the same accounting period. When the financial year of a subsidiary differs from that of the parent, interim financial statements should be prepared to the same date as the parent or if not practical the financial statements of the subsidiary for the last financial year should be used providing that the year ended not more than 3 months before the parent year end.

Definitions: Control The ability of an undertaking to direct the financial and operating policies of another undertaking with a view to gaining economic benefits from its activities. Dominant Influence Influence that can be exercised to achieve the operating and financial policies desired by the holder of the influence, notwithstanding the rights or influence of any other party. Equity Method A method of accounting for an investment that brings into the consolidated profit and loss account the investors share of the investment subsidiaries results and that records the investment in the consolidated balance sheet at the investors share of the investments net assets including any goodwill arising to the extent that it has not previously been written off. Interest Held on a Long-term Basis An interest that is held other than exclusively with a view to subsequent resale. Interest Held Exclusively with a view to Subsequent Resale (a) An interest for which a purchaser has been identified or is being sought, and which is reasonably expected to be disposed of within approximately one year of its date of acquisition; or (b) An interest that was acquired as a result of the enforcement of a security, unless the interest has become part of the continuing activities of the group or the holder acts as if it intends the interest to become so. Managed on a Unified Basis Two or more undertakings are managed on a unified basis if the wholes of the operations of the undertakings are integrated and they are managed as a single unit. Unified management does not arise solely because one undertaking manages another.

Minority Interest in a Subsidiary Undertaking The interest in a subsidiary undertaking included in the consolidation that is attributable to the shares held by or on behalf of persons other than the parent undertaking and its subsidiary undertakings.

Restrictions on Distribution: Where significant restrictions on distributions by a subsidiary exist the nature and extent of the restrictions should be disclosed.

When we look at consolidations the key word is CONTROL rather than ownership of the shares.

Extraordinary Items: Under FRS 2 we are now required to show the subsidiarys total Extraordinary Item and to allocate a share of this to Minority Interest if appropriate. Pre Acquisition Dividends

Traditionally dividends paid to holding companies out of pre-acquisition profits have been treated as a return of the capital paid to acquire the company and not as profit in the hands of the holding company. Therefore this dividend was treated as reducing the cost of the investment in the holding companys balance sheet. However, the more widely accepted view of the law in this area seems to have changed. The question as to whether a dividend from a subsidiary to the holding company is available for onward distribution by the holding company depends on whether receipt of the dividend can be regarded as giving rise to a realised profit in the financial statements of the holding company and not simply whether it derives from the pre or post acquisition profits of the subsidiary. Because the law and accounting practice require provisions to be made only for permanent diminution in the value of a fixed asset, it is possible to say that as long as the investment recovers the value lost through the distribution of profits then it is unnecessary to write down the cost of the investment in the holding companys books and the dividend may be passed on to the holding companys shareholders.

Where the investment is carried at fair value, it is likely that a dividend which represents a return of pre-acquisition profits would give rise to a diminution in the value of investment and thus should be applied in reducing the cost (carrying value) of that investment. However, if this diminution is not permanent, this treatment is not mandatory. Thus companies could distribute all the subsidiaries pre-acquisition profits as long as the subsidiary could replace them in the future. This practice may be legal but it offends good accounting practice. The preacquisition dividend is a return of the purchase price and it seems right to deduct it from the cost of the investment. Where merger accounting is used and the cost of the investment is recorded at the nominal amount of the shares issued plus any cash payment, there would be no need to deduct the dividend from the cost of the investment unless the dividend reduces the value of the subsidiary below the carrying amount in the financial statements of the holding company. It seems that the treatment that will be adopted in financial statements must be determined by the circumstances of the case involved

FRS 7 FAIR VALUES IN ACQUISITION ACCOUNTING (Sept 94) This fairly controversial accounting standard sets out the general principles governing the ASBs proposals for the identification and valuation of assets and liabilities when an acquisition takes place. The underlying concept is to prevent the avoidance of costs bypassing the profit and loss account. This had reached the stage in practice whereby goodwill had become a fixed amount instead of representing the balancing figure in the fair value calculation. In Ireland, for example, the average percentage of reorganisation provisions to goodwill averaged 19% in 1993 and the provision was found in nearly every major acquisition. The proposed standard sets out to tidy up the process by regarding an acquisition as a two-stage process as follows: Stage 1 An acquirer should calculate goodwill by comparing the fair value of the purchase consideration with the fair value of the net assets acquired. However this must only include those assets and liabilities that existed at the date of acquisition using the acquirers accounting principles.

Stage 2 Any post acquisition provisions for reorganisation / restructuring costs should be provided as post acquisition expenses and thus provided for through profit and loss accounting. Considerable opposition has emerged from industry, particularly on the proposed banning of reorganisation provisions which they believe are an inherent part of the fair value exercise and in determining the price paid for a business. Donald Main, one of the members of the ASB, has actually dissented from the standard and he argues that at the time of acquisition acquirers have a good knowledge of the funds necessary to restructure the target company and therefore these are discounted in the price paid by the acquirer and should therefore be permitted. The ASB understand this issue but find it impossible to segregate between genuine reorganisation and those which represent deliberate manipulation of the goodwill figure. It is safer to ban them. Financial Reporting Standard Objective All assets and liabilities are to be recorded at their fair value on acquisition reflecting their condition as at that date. All subsequent changes post control date should be reflected as part of post acquisition performance. Definitions Acquisition A business combination that is accounted for by adopting acquisition accounting. Date of Acquisition The date on which control passes to the acquirer (as per FRS 2). Fair Value The amount at which an asset / liability could be exchanged between a willing buyer and a willing seller at arms length. Identifiable Assets and Liabilities Those that are capably of being disposed of or settled separately. Recoverable Amount

The greater of the net realisable value of an asset and that recoverable from further use. Scope Applicable to all financial statements intending to give a true and fair view of an entitys financial position and profit / loss for a period. Determining the Fair Values of Identifiable Assets and Liabilities Acquired Principles of Recognition and Measurement Identifiable assets/liabilities are those that existed as at the date of acquisition and should be measured at fair values that reflect the conditions at the date of acquisition. Investigation Period and Goodwill Adjustments This should be completed by the date that the first post acquisition financial statements are approved by the directors. Provisional valuations should be made if this is not possible and amended by the next set of accounts. Any necessary adjustments to provisional fair values must be made by the first full financial statements published post acquisition. Any further adjustments will be by way of prior year adjustments (if fundamental errors) or as profits / losses when identified.

Determining the Cost of Acquisition The fair value of the purchase consideration plus expenses equals the cost of acquisition. If the acquisition is in stages, the cost is the total of the costs of interests acquired at each transaction date. Disclosures These are now contained within FRS 6 Mergers and Acquisitions. Date From Which Effective Standard accounting practice for all accounting periods beginning on or after the 23 December 1994. Other Issues

Disclosure of Provisions for Reorganisation Costs Possible additional exceptional item outside operating profit. This was rejected as being too confusing and difficult for users to draw a clear distinction from. Instead a fuller disclosure in the notes was regarded as a more appropriate solution. Pension Surpluses The FRS argues that it is only possible to provide for a liability (deficiency) but not for an asset (surplus). FRS 7 has concluded that an asset can be created, but the timescale and extent of realisations should be carefully monitored before it can be recorded in the financial statements. Acquisition Expenses FRS 7 felt that internal costs should not be permitted as there was a possibility of excessive costs being capitalised. Also the determination of such costs was deemed to be very subjective. Application of the Principles The following do not affect fair values at the date of acquisition and should be treated as post acquisition items: a) b) c) changes resulting from the acquirers future intentions or actions. provisions for future impairments in value. provisions for reorganisation and integration costs.

The assets / liabilities acquired should be identified and value using the acquirees accounting policies. Tangible Fixed Assets Should be valued normally at open market value (if available) or at depreciated replacement cost. The valuation adopted should not exceed the recoverable amount of the asset. Intangible Fixed Assets Should be valued at current replacement cost, normally at their estimated value in the market. Stocks and Work in Progress

Should be valued at the lower of replacement cost and NRV. However, commodity stocks should be valued at their market value. replacement cost should reflect normal buying processes. Quoted Investments Should be valued at current market value. Where the size is such that the market is not capable of absorbing if without a material effect on its quoted price, the market price should be adjusted to reflect the exchange values.

Monetary Assets / Liabilities Monetary assets / liabilities should be valued at the amounts received or paid as well as their timing. Fair values should be determined by reference to market prices, where available, by reference to their acquisition price or by discounting them to present values. Businesses Held Exclusively with a view to Subsequent Resale Value at NRV unless the disposal is completed at a value demonstratively different from its fair value at the date of acquisition provided that: a) b) c) assets, liabilities and results are clearly distinguishable physically, operationally and for financial accounting purposes. a purchaser has been identified or is being sought. the disposal is reasonably expected to occur within one year of acquisition.

This asset should be disclosed within current assets or current liabilities. However, if the subsidiary is not sold within one year of acquisition, it should be consolidated in the normal manner. Contingencies Value at fair value where they can be determined, and for this purpose there is a need to adopt reasonable estimates. Pensions and other Post Retirement Benefits

The fair value of a deficiency or to the extent that it is reasonably expected to be realised, a surplus in a funded pension scheme should be recognised as an asset /liability. All subsequent changes are post acquisition. Deferred Taxation Should recognise deferred taxation in the fair value exercise by considering the enlarged group. The benefit of tax losses should also be recognised as per SSAP 15. Appendix iv Dissenting View - D Main (Director - Forte plc) Main argues that it is very rare for a company to acquire another and not make substantial changes to make the acquiree more efficient. It requires reorganisation. The facts and related costs are known to the acquirer at the time of acquisition and are incorporated in the purchase consideration and compared with projected future earnings. A ban on reorganisation provisions leads, in his view, to the publication of misleading financial statements. Reorganisation provisions are part of the single investment decision and he believes that the FRS has excessively reacted to perceived abuse in practice. He also outlines the considerable opposition to the standard from industry in general and argues that auditors are only happy with the standard because it avoids the subjectivity surrounding the valuation of these provisions. He also argues that as an alternative, the ASB could have redefined reorganisation costs more clearly and could have adopted stricter disclosure. However, he would still ban any provisions for future foreseeable losses.

FRS 6 ACQUISITION AND MERGERS (September 1994) The overall approach of this accounting standard is that true mergers are rare species (Merger accounting has been banned in the US) and therefore most business combinations should be accounted for under the acquisition method of

accounting. As such it sets out 5 criteria that must be met before a combination can be treated as a merger as follows: No party is portrayed as an acquirer or acquiree; All parties must participate in drawing up the new management structure; Both companies are roughly the same size; No more than an immaterial percentage of the fair value of the consideration can be in the form of non equity shares; There should not be any earn out clauses.

It was originally suggested in FRED 6, the prelude to the standard, that an alternative approach might have been to ban merger accounting altogether except in the case of group reconstructions. However this was rejected by the ASB in FRS 6. However, David Tweedie has made it clear that he does not expect to see more than one or two true mergers every year. FRS 6 contains all the detailed disclosures for both acquisition and merger accounting. Acquisition Accounting The acquisition of one company by another and the inclusion of assets at their fair value in the consolidated balance sheet and of their share of profits / losses from the date of acquisition. Any difference between the fair value of the consideration given and the net assets acquired is regarded as goodwill. Acquisition accounting must be adopted if an acquirer can be identified. Merger Accounting Both companies are on an equal footing, no fair value exercise is carried out and the inclusion of a FULL set of results of each party for the whole of the accounting period is included in the consolidated accounts, even though the combination occurs during the year. There are 5 criteria listed to determine whether merger accounting is acceptable and these include:

The manner in which the roles of each party to the combination are portrayed. Involvement of each party in the selection of the management of the new entity. Relative sizes of both parties. Whether any non share consideration is received by the parties on combination. Whether any earn out clauses exist.

If these criteria are not met then acquisition accounting must be adopted. The Objectives of FRS 6 are as follows: 1. To restrict merger accounting to those combinations that are not in substance the acquisition of one entity by another, but the formation of a new reporting entity as a substantially equal partnership where no one party is dominant. To ensure that acquisition accounting is applicable to all other combinations. To ensure that the financial statements provide relevant information about the effect of the combinations.

2. 3.

Definitions Business Combination The brining together of separate entities into one economic entity as a result of one entity uniting with, or obtaining control over, the net assets and operations of another. Merger A business combination which results in the creation of a new reporting entity formed from the combining parties, in which the shareholders come together in a partnership for the mutual sharing of risks and benefits of the combined entity, and in which no party to the combination in substance obtains control over any other, or is otherwise seen to be dominant, whether by virtue of the proportion of its shareholders rights in the combined entity, the influence of its directors or otherwise. Acquisition A business combination that is not a merger. Statement of Standard Accounting Practice

Scope Applicable to all financial statements intending to give a true and fair view. Use of Merger Accounting A combination should be accounted for as a merger if: a) The use of merger accounting is not prohibited by the Companies Act; and b) The combination meets all the specific criteria set down by the standard. Acquisition accounting should be adopted in all other circumstances. Individually the criteria set down are insufficient to define the intangible quality of a true merger but taken as a whole they provide a reasonable basis for determining whether a business combination is a merger or an acquisition. It is necessary to look at the substance. The criteria for determining whether the definition of a merger is met are: 1. Role of Parties No party to the combination is portrayed as either acquirer or acquired A merger must be a genuine merging of interests and this cannot exist if one party portrays itself as having a dominant role in the new entity or else being subservient. A premium over market value is an indication of an acquisition. The overall circumstances, however, should be investigated e.g., the form by which the combination was achieved, any future plans such as closures or disposals and the proposed corporate image of the new entity e.g. logo, location of HQ and principal operations. Dominance of Management All parties participate in establishing the management structure for the combined entity and in selection of the management personnel. Decisions should be on the basis of consensus between the parties and not purely by an exercise of voting rights. If one party clearly dominates or if a decision requires the exercise of a majority vote, this indicates that it is an acquisition. However it is possible that in a merger the majority of the management team could come from one party. There is a need to identify the key decision makers and how the decision making operation works in practice.

2.

3.

Relative Sizes of the Parties

The relative sizes of the combining entities are not so disparate that one effectively dominates the others - it is not an equal partnership in that situation. There is a presumption that domination will exist if one party is more than 50% larger than the other in relation to overall equity interests. This may be rebutted if it can clearly be shown that there is no such dominance e.g. blocking powers etc. 4. Non Equity Consideration No more than an immaterial proportion of the fair value of consideration should be in the form of non equity shares. Any acquisitions in the previous two years should be taken into consideration in arriving at this figure. It should, however, exclude the distribution to shareholders of interest and proceeds of a peripheral part of the business prior to combination. This condition is in addition to the Companies Act (UK) requirement that the fair value of any consideration other than the issue of equity shares does not exceed 10% of the nominal value of the equity shares issued.

5.

Minorities No equity shareholders of the combined entities retain any material interest in the future performance of part only of the combined entity. There should be a mutual sharing of risks and rewards in the new entity including the pooled future results of the combined entity. Any consideration dependant on post combination performance to be paid to one of the parties would be incompatible with a merger or if there are earn out clauses or if there is a substantial minority interest left in one of the entities. The Companies Act (UK) requirements specify a maximum minority interest of 10%. Merger Accounting - Typical Characteristics 1. No adjustment to the fair value of the net assets of the combining entities is required but there is a need to achieve uniformity of accounting policies within the group. The full results of the combining entities for the year should be brought into the financial statements without any adjustments except for the need to ensure a uniformity of according policies within the group. There is a need to adjust the comparable figures on the same basis. The nominal value of shares issued less the nominal value of shares purchased will lead to an adjustment which must be taken direct to reserves but it is not regarded as goodwill.

2.

3.

4.

Any merger expenses should be charged directly through the profit and loss account and reported as a reorganisation or restructuring expense (per FRS 3).

Acquisition Accounting - Typical Characteristics 1. The acquired companys net assets should be valued at fair value at the date of acquisition. Only the post acquisition results should be entered into the profit and loss account and balance sheet from the date of acquisition. There should be no adjustment to comparable figures.

2.

3. 4.

The fair value of the purchase consideration less the fair value of the net assets acquired shall represent goodwill. Disclosure Acquisitions and Mergers 1. 2. Names of the combining entities. A statement as to whether the combination has been accounted for as an acquisition or a merger. The date of the combination.

3.

Comparison of Merger Method of Accounting with Acquisition Method 1. Under the merger method, assets are recorded at their previous value < book values > as there is no requirement to record them at fair value. No share premium arises in the books of the holding company as shares issued are recorded at their nominal value. A premium on acquisition (goodwill) will never arise under the merger method. There is no distinction between pre and post acquisition reserves. As one adjustment is normally only required it is generally considered to be an easier and simpler method of consolidation.

2.

3. 4. 5.

Merger Accounting - Specific Consolidation Adjustment

America plc has decided to combine with Europe plc and has made a successful one for one offer to the ordinary shareholders of Europe plc. Ordinary shares in America plc are quoted on the Stock Exchange at 2.20. The balance sheets of the two companies are set out below: America plc 2,800 1,400 4,200 3,000 1,200 4,200 Europe plc 2,400 800 3,200 2,000 1,200 3,200

Fixed assets Net current assets

Ordinary shares of 1 each Reserves (realised)

Required Prepare a consolidated balance sheet on a merger basis for America plc. (a) (b) (c) using the information given above; assuming that the offer had been 3 shares in America plc for every 2 shares in Europe plc; assuming that the offer had been 1 share in America plc for every 2 shares in Europe plc;

Solution The investment in Europe plc shown in the accounts of America plc will be as follows. Under (a) Under (b) Under (c) 2,000 3,000 1,000

Consolidated Balance Sheets (a) 5,200 2,200 7,400 5,000 2,400 7,400 (b) 5,200 2,200 7,400 6,000 1,400 7,400 (c) 5,200 2,200 7,400 4,000 1,000 2,400 7,400

Fixed assets Net current assets

Ordinary shares of 1 each Unrealised reserve Realised reserves

The balance sheet in (a) shows no change in the total realised reserves. This is because the nominal value of the shares acquired exactly matches the nominal value of the shares issued. The balance sheet in (b) reflects the fact that America plc has issued 3,000 shares, whose nominal value is 1,000 more than the nominal value of the shares taken over. The difference is deducted from realised reserves, since the group has no unrealised reserves. The balance sheet in (c) includes an unrealised reserve, created because the nominal value of the shares issued is 1,000 less than the nominal value of the shares acquired. Merger Accounting Irish Law Problem Regulations 21 and 22, European Communities (Companies: Group Accounts) Regulations, 1992, specify the qualifying criteria for and the method of applying merger accounting. However, where the share exchange includes shares issued at a premium to their nominal value, Section 62(1) Companies Act, 1963, requires the amount of that premium to be transferred to the share premium account. Subject to the directors and auditors of the company certifying that it would be fair and reasonable to override the prohibition, (Section 149(5), Companies Act, 1963), the payment by a holding company of dividends out of pre-acquisition profits of its subsidiary is forbidden. This requirement reflects the view that a dividend received from the subsidiary out of its pre-acquisition profits represents a return of the capital paid to acquire that subsidiary and should therefore be applied to reduce the cost of the investment in the holding companys balance sheet. However, currently it would be argued that such dividend received should only be applied to reduce the carrying value of the investment in the accounts of the holding company where this is necessary to provide for a diminution in value of the cost of

investment in the subsidiary undertaking. Where such provision for impairment is not considered necessary and the dividend constitutes a realised profit in the financial statements of the holding company it appears appropriate to treat the amount received as part of the distributable profits of the holding company. The Company Law Review Group have been asked to consider revising Section 149(5) to reflect what is currently considered to be good accounting practice.

FRS 9 Associates and Joint Ventures Financial Reporting Standard 9 'Associates and Joint Ventures' sets out the definitions and accounting treatments for associates and joint ventures, two types of interests that a reporting entity may have in other entities. The FRS also deals with joint arrangements that are not entities. Summary Subsidiary - Control Control is the ability of an entity to direct the operating and financial policies of another entity with a view to gaining economic benefits from its activities. Consolidate the financial statements as per FRS 2. Joint Venture - Long term and shared control Acting together the venturers can control the entity and each venturer has veto over strategic issues. Account as for an associate but double the disclosures JANE - Joint venture that is not an entity Account for your own assets and profits Associate - Participating interest and significant influence (Account in B/S as cost plus group share of post acquisition profit of associate and in P/L as group share of this years profit) Investment - limited influence or only short term influence Cost plus dividends received How to do the accounting in detail Subsidiaries The investor should consolidate the assets, liabilities, results and cash flows of its subsidiaries.

Joint Each party should account for its own share of the assets, arrangements; liabilities and cash flows in the joint arrangement, measured that are not according to the terms of that arrangement, for example pro entities rata to their respective interests.

Joint ventures The venturer should use the gross equity method showing in addition to the amounts included under the equity method*, on the face of the balance sheet, the venturer's share of the gross assets and liabilities of its joint ventures, and, in the profit and loss account, the venturer's share of their turnover distinguished from that of the group. Where the venturer conducts a major part of its business through joint ventures, it may show fuller information provided all amounts are distinguished from those of the group. Appendix IV sets out an optional columnar presentation.

Associates: The investor should include its associates in its consolidated financial statements using the equity method. In the investor's consolidated profit and loss account the investor's share of its associates' operating result should be included immediately after group operating result. From the level of profit before tax, the investor's share of the relevant amounts for associates should be included within the amounts for the group. In the consolidated statement of total recognised gains and losses the investor's share of the total recognised gains and losses of its associates should be included, shown separately under each heading, if material. In the balance sheet the investor's share of the net assets of its associates should be included and separately disclosed. The cash flow statement should include the cash flows between the investor and its associates. Goodwill arising on the investor's acquisition of its associates, less any amortisation or write-down, should be included in the carrying amount for the associates but should be disclosed separately. In the profit and loss account the amortisation or write-down of such goodwill should be separately disclosed as part of the investor's share of its associates' results.

Simple

The investor includes its interests as investments at either

investments

cost or valuation.

Disclosures: All Name, %, special rights, accounting date, nature of business, accounting policies (where they have an effect), contingent liabilities, Debtors and creditor balances with, any 20% rebuttal. 15-25% additional disclosures(of Gross assets, Gross liabilities, turnover, operating results 3 year average) turnover (unless it is already included as a memorandum item), fixed assets, current assets, liabilities due within one year, liabilities due after one year or more. 25% additional disclosures turnover, profit before tax, taxation, profit after tax, fixed assets, current assets, liabilities due within one year, liabilities due after one year or more. Other points Participating interest - Presumed at 20%+ but this can be rebutted Significant influence - e.g. can appoint a director, can determine dividend policy, Holding Companies own accounts - all are treated as investments and subject to impairment review if necessary If there are losses in the JV venturers may decided to "withdraw" from control (therefore only consolidating the dividends received and not the losses). This can only be achieved following a public statement, and "demonstrate commitment" to the withdrawal. Where an investor does not prepare consolidated financial statements, it should present the relevant amounts for associates and joint ventures, as appropriate, by preparing a separate set of financial statements or by showing the relevant amounts, together with the effects of including them, as additional information to its own financial statements. Investing entities that are exempt from preparing consolidated financial statements, or would be exempt if they had subsidiaries, are exempt from this requirement.

Examples (Normal) CONSOLIDATED PROFIT AND LOSS ACCOUNT Turnover: group and share of joint ventures Less: share of joint ventures' turnover Group turnover Cost of sales Gross profit Administrative expenses Group operating profit Share of operating profit in Joint ventures Associates 320 (120) ----200 === (120) ---80 (40) ---40

Interest receivable (group) Interest payable Group Joint ventures Associates

30 24 ---54 ---94 6

(26) (10) (12) ---(48) ---52

Profit on ordinary activities before tax

CONSOLIDATED BALANCE SHEET

Fixed assets Tangible assets Investments Investments in joint ventures: Share of gross assets Share of gross liabilities

480

Investments in associates

130 (80) ---50 20 --550 15

Current assets Stock

See FRS 9 for an alternative allowable presentation