means that subsidiaries can now be companies, partnerships and associations carrying on a trade or a business. an undertaking does not have to have to be a company, or have a profit motive. subsidiaries can be companies, partnerships, or unincorporated associations where a holding company controls the board of directors of another undertaking.
The holding company is legally required to prepare consolidated accounts for the group, thus subsidiaries will not be shown in the group’s fixed asset investments, as their assets and liabilities are included in the group’s accounts. However, they will show as a fixed asset investment in the parent company’s balance sheet (usually published alongside the group balance sheet).
● PARTICIPATING INTERESTS
A participating interest is defined by the Companies Act (s 260) as: ‘an interest held by an undertaking in the shares of another undertaking which it holds on a long-term basis for the purpose of securing a contribution to its activities by the exercise of control or influence aris- ing from or related to that interest’.
The rules for determining participating interests are similar to those used for associates (see below). A shareholding of 20 per cent (including any options or convertible securities) or more is deemed to be a participating interest, unless evidence to the contrary can be shown.
Most participating interests are also associates, as a participating interest becomes an associ- ate when a significant influence is exercised over the operating and financial policy.
● ASSOCIATED UNDERTAKINGS
An associated undertaking is one where the company has a participating interest in a long- term investment and exercises significant influence over the operational and financial poli- cies of the associate.
●
Accounting for associates
Accounting for associates is covered by FRS 9 (Associates and Joint Ventures), which becomes effective on 23 June 1998. The investment in associated undertakings must be accounted for using some version of the ‘equity method’.
●
The equity method
The equity method is effectively consolidation on one line of the balance sheet. Rather than detailing all of the associate’s assets and liabilities , the group determines its share of the asso- ciate’s net assets. The value of the investment on the balance sheet will also include any A subsidiary is not necessarily a company, because since 1989 the definition has included partnerships and unincorporated associations where the investing company controls the business. Hence, the term undertaking. Subsidiaries only appear as fixed assets in the parent company’s balance sheet. In the group accounts the assets and liabilities are con- solidated.
SUMMARY
unamortised goodwill arising on the acquisition of the associate. The investment is initially shown at cost, and the subsequent value is then adjusted for the investing company’s share of any changes in the associate’s net assets. Consequently, the balance sheet will show the investor’s share of the associate’s net assets plus the goodwill arising from the acquisition of the investment. Any goodwill will be disclosed in the accounts, but is shown as part of the value of the investment and is not included with the goodwill shown as an intangible asset.
The investing company incorporates into its consolidated profit and loss account its share of the associate’s operating profit, and all subsequent profit and loss account items, other than dividends. The consolidated cash flow statement discloses the dividends received from associates as a separate heading, with other cash flows between the investor and its associ- ates being shown under the appropriate heading. The consolidated statement of total recog- nised gains and losses will include the investor’s share of gains and losses, which are separately disclosed either within the statement or in the notes to the statement.
The investor will also have to disclose:
● The name of each associate, showing for each the proportion of each class of shares owned by the group, disclosing any special rights or constraints.
● Material notes to the associate’s accounts that are necessary for an understanding of the effect on the investor of its investments, noting the investor’s share of any contingent lia- bilities and capital commitments.
● The extent of any restrictions on the distributions of reserves arising from exchange con- trols, statutes, or contracts.
● Disclosure of amounts owed and owing to associates, together with other disclosures required FRS 8 (Related Party Transactions).
The Stock Exchange’s listing rules require listed companies to disclose the following infor- mation for all companies where the investing company’s holding is 20 per cent or more:
● the principle country of operation
● the issued capital and debt securities
● the percentage interest in each class of security.
These apply regardless of whether the company is accounted for as an associate.
The accounting treatment for associates is illustrated in the following example.
We will assume that our predator buys 30 per cent of the victim for £20 000. The total net assets of the victim were £50 000. Therefore the goodwill will be £5000 as the predator’s share of the net assets will be £15 000. (£20 000 – £50 000 x 30 per cent). On the date of acquisition the investment will be shown at the cost of £20 000 and the goodwill of £5000 will be disclosed in the accounts.
The balance sheet of the predator will be as follows:
Pre-acquisition Post-acquisition
£000 £000
Fixed assets:
Tangible fixed assets 100 100
Investments
Associate ...20
120 EXAMPLE
9 Associated undertakings Current assets:
Stock 30 30
Debtors 70 70
Cash .100 ...80)(100–20)
200 180
Creditors: amounts falling due within a year:
Creditors (110) (110)
Net current assets ...90 ...70
Total assets less current liabilities 190 190
Creditors: amounts falling due in more than a year:
Loans ...(30) ...(30)
.160 .160
Capital and reserves:
Share capital 50 50
Profit and loss account .110 .110
160 160
The predator and victim’s profit and loss accounts for the year following the acquisition were:
Predator Victim
£000 £000
Turnover 1000 100.0
Operating costs (750) (80.0)
Operating profit 250 20.0
Interest payable (50) (10.0)
Profit before tax 200 10.0
Tax (60) (3.3)
Profit after tax 140 6.7
Dividend (20) –
Retained profit 120 6.7
The predator has to include its 30 per cent share of the victim’s operating profits (£6000), interest (£3000) and tax charge (£1000) into its consolidated profit and loss account, which is shown below:
£000 £000
Turnover 100.0
Operating costs (750)
Operating profit 250
Share of associate’s operating profits 6
Interest payable:
Group (50)
Associate 0(3) (53)
Profit on ordinary activities before tax 203
Tax on profit on ordinary activities* (61)
Profit after tax 142
Dividend (20)
Retained profit for the group and its share
of associates 122
The tax charge relates to the following:
Parent and subsidiaries (60)
Associate (1)
The earnings have risen but there has been no additional cash input into the predator’s busi- ness, as the associate did not pay a dividend! (Dividends would be the main source of cash to the predator, and the only form of permanent cash. There are occasions when the associate will lend the investing company money. These are disclosed, separately among the creditors, as amounts owed to associated undertakings.)
The value of the investment shown in the predators’ balance sheet will rise to £22 000 – the
£20 000 cost plus the £21 000 retained profit from the associate. The predator’s proportion of the victim’s profit, less any dividends paid from this profit, will be added to the value of the investment shown on the balance sheet. This ensures that the value of the investment reflects both the cost and the predator’s proportion of the victim’s retained profit or loss, since the date of acquisition.
If the victim had paid a dividend of £5000, its retained profits would be £1700 (£6700 –
£5000 dividends paid). The predator would have received £1500 cash from the dividend that would not have shown on the consolidated profit and loss account, but will be reflected on the balance sheet in increased cash balances. Therefore the predator would increase the value of the investment on the balance sheet by £500 (£2000 shown in the profit and loss account, less the £1500 dividends received). This reflects the predator’s share in the victim’s net worth. Thus, the value of the investment shown on the balance sheet would be £20 500 – the cost plus the predator’s share of the post-acquisition retained profits. (This also equals the predator’s share of the net assets, 30 per cent of £50 000, £15 500, plus the goodwill of £5000.
Equity accounting is clearly illustrated in Extracts 9.1 and 9.2 from Taylor Woodrow’s 1996 accounts. Taylor Woodrow’s accounting policy for associates is shown in Extract 9.1.
9 Associated undertakings
Taylor Woodrow’s unincorporated joint ventures are accounted for using proportional consolidation (this method of accounting is discussed later in the chapter).
Its operating profits were £73.3 million in 1996. Its share of associates’ profits showed below operating profit and was £2.9 million.
The note on investments in associates is shown in Extract 9.2.
Borrowing from associates could be very important. In the creative accounting boom of the 1980s, companies would use associates as a way of getting loans off their balance sheets.
The associate would have a loan that the investing company was liable for, and the associ- ate would then lend the money to the investing company. Neither the loan nor the interest showed in the investing company’s accounts as borrowings or interest. The associate was equity accounted, not consolidated. There were, however, two clues – loans from associates and a note in the contingent liabilities that the company had guaranteed the debt of an asso- ciate. The off-balance-sheet funding was usually very blatant, but was often ignored by ana- lysts. The ASB has tried to close this loophole with FRS 2 (Accounting for Subsidiary Undertakings) and FRS 5 (Reporting the Substance of Transactions). The additional disclosure requirements of FRS 9 will make any off-balance-sheet funding transparent.
●
Joint ventures
A joint venture is a long-term investment in a business that is trading in its own right and is jointly controlled by the reporting company and others under a contractual arrangement.
Following the implementation of FRS 9, in June 1998, joint ventures are consolidated using the gross equity method, which expands the information shown in the balance sheet and profit and loss account using the equity method. The information in the cash flow statement and the statement of total recognised gains and losses is the same as that given for associates using the equity method.
The equity method is one-line consolidation on the balance sheet, the gross equity method is a three-line consolidation showing the gross assets and liabilities underlying the net investment in the joint venture. It also expands the information shown in the consoli- dated profit and loss account showing the joint venture’s turnover, which should be clearly distinguished from the turnover of the group. The company’s share of the operating profit and subsequent profit and loss account items will be shown in the normal way. Items from operating profit to profit before tax should be shown separately from group figures, whereas items following profit after tax may be included in group numbers on the face of the profit and loss account but should be separately disclosed.
An associated undertaking is defined as an undertaking other than a subsidiary undertaking or an unincorporated joint venture in which the group has a participating interest and over whose operating and financial policy it exercises significant influence.
The group’s share of the post-acquisition results of associated undertakings is shown in the consolidated profit and loss account.
Investments in associated undertakings are included in the consolidated balance sheet at cost less premiums including loans plus the appropriate shares of post-acquisition results and reserves as disclosed in the latest balance sheets. Premiums are written off against retained profit and loss account.
ASSOCIATED UNDERTAKINGS (TAYLOR WOODROW) Extract 9.1
2 + 2 = 5
Shares Share of
Cost and share of reserves unlisted reserves Loans Total
£m £m £m £m
31 December 1995 7.5 6.0 1.4 14.9
Changes in exchange rates (0.1) (0.9) – (1.0)
Additions – 1.2 – 1.2
Reductions (1.5) (2.6) (1.4) (5.5)
31 December 1996 5.9 3.7 – 9.6
Amounts provided
31 December 1995 2.6 – – 2.6
Changes in exchange rates (0.5) – – (0.5)
Reductions (0.2) – – (0.2)
Charge for year 1.4 – – 1.4
31 December 1996 3.3 – – 3.3
Net values
31 December 1996 2.6 3.7 – 6.3
31 December 1995 4.9 6.0 1.4 12.3
The directors’ estimate of the value of unlisted investments was
31 December 1996 6.3
31 December 1995 10.9
Dividends received
31 December 1996 2.5
31 December 1995 0.3
INVESTMENTS IN ASSOCIATED UNDERTAKINGS (TAYLOR WOODROW) Extract 9.2
If the associate shown in the example had been a joint venture where the group had a 30 per cent interest, the consolidated profit and loss acount would be as follows:
£000 £000
Turnover: group and share of joint ventures 1030 Less: share of joint venture’s turnover (30)
Group turnover 1000
Operating costs (750)
Operating profit 250
Share of joint venture’s operating profits 6
Interest payable:
Group (50)
Joint venture 0(3) (53)
Profit on ordinary activities before tax 203
Tax on profit on ordinary activities* (61)
Profit after tax 142
Dividend (120)
Retained profit for the group and its share of associates 122
*The tax charge relates to the following:
Parent and subsidiaries (60)
Joint venture (1)
If the group’s share of the joint venture’s net assets was £24 000, comprising £40 000 gross assets and £16 000 gross liabilities, the consolidated balance sheet would show the investment as follows:
£000 £000
Investments
Investment in joint ventures:
Share of gross assets 40
Share of gross liabilities (16)
24
●
Significant associates and joint ventures
Additional disclosures have to be made where a significant part of a company’s business is conducted through associates or joint ventures. These are required when the associates or joint ventures exceed 15 per cent of the investing group’s:
● gross assets
● gross liabilities
● turnover
● operating result (on a three-year average).
If these thresholds are exceeded the investing company gives additional information about the gross assets and liabilities, disclosing:
9 Associated undertakings EXAMPLE
● fixed assets
● current assets
● liabilities due within a year
● liabilities due in more than a year
● any other information that is necessary to understand the total amounts disclosed, for example the size of the debt and its maturity.
If an individual associate or joint venture exceeds 25 per cent of the thresholds shown above, the same information should be disclosed for the individual investment.
INTERNATIONAL DIFFERENCES
The UK practice is broadly representative of practice internationally in accounting for asso- ciates, but there are differences in accounting for joint ventures.
The accounting requirements for associates in FRS 9 and IAS 28 (Accounting for Associates) are broadly similar. There are some minor differences, but the most important between the two standards lies in the definition of an associate. The two standards have different defini- tions of ‘significant influence’. IAS 28 defines significant influence as ‘the power to participate in the financial and operating decisions in the investee’, whereas FRS 9 requires the actual exercise of this influence. Consquently a company would not be regarded as an associate under UK rules if the investor had the power to influence financial and operating decisions, but did not do so. The additional disclosures for major associates are not required by the inter- national standard.
There are a number of differences in both the definition and accounting for joint ventures.
IAS 31 (Financial Reporting of Interests in Joint Ventures) defines a joint venture as a contractual arrangement whereas FRS 9 defines a joint venutre as an entity that is under joint control.
Therefore, jointly controlled assets and operations would not be a joint venture under UK accounting rules, whereas they would be under the international standard. Proportional con- solidation is the benchmark treatment in IAS 31 with the equity method as the allowed alter- native. The international standard requires additional disclosures for all jointly controlled entities, whereas FRS 9 only requires certain additional disclosures for joint ventures exceed- ing the thresholds given earlier in the chapter.
The definition of an associate is broadly similar in all of our comparative countries, and they all use the equity method to account for associates. There are, however, some differ- ences in accounting for joint ventures. The European Seventh Directive allows member states to permit or require proportional consolidation for joint ventures. In France it must be used, whereas in Germany and the Netherlands it may be used. In Canada, Japan and the USA the equity method is used.
●
Other statutory disclosure requirements
The Companies Act requires that the following additional information about associates be disclosed in the investing company’s accounts:
● its name;
● the country in which it is incorporated (together with the country of registration if the company is incorporated in Great Britain), or the principal place of business if it is unin- corporated;
● the proportion and identity of each class of share held by the parent and the group as a whole.
This information has an obvious interest to the analyst, and is illustrated by the following extract from Taylor Woodrow’s 1996 accounts.
9 Associated undertakings
Name of joint venture Address of principal place Taylor Woodrow plc interest in
(*Interests held of business joint venture capital
by subsidiary undertakings) Construction
Costain Building & Civil 345 Ruislip Road, Southall, 50%
Engineering Limited/ Taylor Middlesex UB1 2QX Woodrow Civil Engineering
Limited Jubilee Line Extension 104 Joint Venture *
Translink Joint Venture* Terminal Sub Project, Beachborough, 20%
Newington, Folkestone, Kent CT18 8NP Housing
Harrington Park Joint Venture* Level 1, 96 Phillip Street, Parramatta, 50 % New South Wales 2150, Australia
Taylor Woodrow/Kenco Limited 7120 South Beneva Road, 39%
(a limited partnership) Sarasota, Florida 34238-2150, USA
The above joint ventures are managed jointly through management boards on which subsidiary undertakings of the group and the other joint venturers are represented in accordance with the respective interests held in the joint ventures.
PARTICULARS OF PRINCIPAL JOINT VENTURES (TAYLOR WOODROW) Extract 9.3
An associate is an undertaking where the investor has a participating interest and exer- cises significant influence in a long-term investment. Associates are accounted for by using the equity method. This brings the investor’s share of the associate’s operating pro- fit and subsequent profit and loss account items into the investor’s profit and loss account. The investment in the associate is separately disclosed on the balance sheet at cost, plus the group’s share of retained profits, since its acquisition. Additional informa- tion will have to be provided if the associate is material within the group.
A joint venture is a long-term investment in an entity trading in its own right that is jointly controlled with other parties under a contractual agreement. Joint ventures are accounted for using the gross equity method. This is a three-line consolidation on the bal- ance sheet showing gross assets and liabilities, and shows more information on the pro- fit and loss account. The joint venture’s turnover is shown and the investing company brings its share of the joint venture’s operating profit and subsequent profit and loss account items into its profit and loss account. Additional information will have to be pro- vided if the joint venture is material to the group.
Investing companies have to disclose information that can be very useful for the ana- lyst, namely:
● who their associates and joint ventures are;
● where they are based;
● the proportion of the associate that they, and the group, own;
● the goodwill relating to the purchase of associates;
● any loans to or from associates;
SUMMARY