Part 3: Consolidation Mechanics (IFRS 10)

IFRS 10 sets the rules for consolidated financial statements when an entity has control over another entity. This part focuses on the mechanics — how to build the statements once control is clear.

1The Definition of Control

Control is the cornerstone of consolidation. Under IFRS 10, an investor controls an investee when it has all three of the following:

1. Power over the Investee

Existing rights that give the investor the current ability to direct the relevant activities — the activities that significantly affect the investee's returns.

2. Exposure to Variable Returns

Returns that can vary as a result of the investee's performance. This includes dividends, interest, fees, changes in investment value, and synergies. Returns can be positive, negative, or both.

3. Ability to Use Power to Affect Returns

The investor must be able to use its power over the investee to affect the amount of the investor's returns. This links power and returns together.

Exam Tip: Control is assessed continuously. If circumstances change, you must reassess whether control still exists. Look for changes in voting rights, contractual arrangements, or board composition.

2De Facto Control

You don't always need >50% of voting rights to have control. De facto control exists when an investor can direct relevant activities even without a majority stake:

Factors Indicating De Facto Control

Size of investor's holding relative to other shareholdings
Dispersion of other shareholders (many small holders)
Pattern of voting at shareholder meetings
Potential voting rights held by the investor

Example

Company A holds 45% of Company B. The remaining 55% is held by thousands of small shareholders who rarely vote. Company A appoints the majority of the board and has historically controlled all shareholder votes. Company A likely has de facto control.

3Consolidation Procedures

Consolidation involves combining the financial statements of the parent and its subsidiaries. Here's the step-by-step process:

Step-by-Step Consolidation Process

1
Combine like items — Add together assets, liabilities, equity, income, and expenses line by line
2
Eliminate parent's investment — Remove the parent's investment in subsidiary against subsidiary's equity
3
Recognize goodwill or bargain purchase — Calculate and present on SOFP
4
Eliminate intra-group transactions — Remove all intercompany balances, sales, dividends
5
Recognize NCI — Present NCI in equity and allocate profit/loss

Remember: The consolidated financial statements present the parent and subsidiaries as a single economic entity. External transactions are shown; internal transactions are eliminated.

4Uniform Accounting Policies

For consolidation, the parent and all subsidiaries must use uniform accounting policies for like transactions and events. If a subsidiary uses different policies:

Required Adjustment

Make adjustments to align the subsidiary's policies with the group's policies before consolidation

Not Acceptable

Mixing different accounting policies (e.g., FIFO and weighted average for inventory) in consolidated statements

Common Policy Differences to Adjust

• Inventory valuation methods (FIFO vs. weighted average)
• Depreciation methods (straight-line vs. reducing balance)
• Investment property measurement (cost model vs. fair value model)
• Revenue recognition timing
• Capitalisation policies for development costs

5Intra-Group Eliminations

All transactions between group entities must be eliminated in full. The consolidated statements should only show transactions with parties outside the group:

📋 Intra-Group Balances

Receivables and payables between group companies cancel out:

Dr Payable to parent (Sub's books)

Cr Receivable from sub (Parent's books)

💰 Intra-Group Sales

Revenue and cost of sales for internal transactions must be eliminated:

Dr Revenue (Seller)

Cr Cost of sales (Buyer)

⚠️ Unrealised Profits in Inventory

If goods sold between group companies are still held in inventory at year-end, the profit is unrealised and must be eliminated:

Dr Cost of sales / Retained earnings

Cr Inventory

Direction matters: For downstream sales (parent → sub), the full unrealised profit is eliminated from parent. For upstream sales (sub → parent), elimination is shared between parent and NCI.

💸 Intra-Group Dividends

Dividends paid by subsidiary and received by parent are eliminated:

Dr Dividend income (Parent's P/L)

Cr Dividends paid (Sub's SOCIE)

Note: Only the parent's share is eliminated. NCI's share of dividends represents a payment to external parties.

6Investment Entity Exception

An investment entity does not consolidate its subsidiaries (except those providing services). Instead, it measures them at fair value through profit or loss.

Investment Entity Criteria (All must be met)

Obtains funds from investors to provide investment management services
Commits to investors that the purpose is to invest for capital appreciation, investment income, or both
Measures and evaluates performance of substantially all investments on a fair value basis

Note: This exception is typically relevant for venture capital entities, private equity funds, and similar investment vehicles. For most exam questions involving operating subsidiaries, normal consolidation applies.

Key Takeaways

Control = 3 elements: Power + variable returns + ability to affect returns.
De facto control: Control possible without majority voting rights.
Line-by-line: Combine all assets, liabilities, income, and expenses.
Uniform policies: Adjust for any differences before consolidating.
Eliminate everything internal: Balances, sales, profits, dividends.

Coming in Part 4...

We'll dive deep into the Analysis of Equity (AOE) — the heart of group accounting. You'll learn to work through at acquisition, since acquisition, and current year columns to derive all your consolidation journals.