Accounting Business Reporting for Decision Making

CHAPTER 5 Balance sheet 171

For companies which have investments in other companies that give them control of those entities’

financial and operating policies, it is necessary to prepare financial statements for the group. Financial

statements presented for the group are referred to as consolidated financial statements or group financial

statements. Thus, the consolidated balance sheet would be reporting the combined assets, liabilities and

equity for the parent entity and the controlled entities as a single economic entity with inter-company

transactions eliminated. A parent entity is an entity that controls another entity. A controlled entity

is referred to as a subsidiary entity. A principle-based approach is used to determine whether or not

an entity controls another entity. Control is present when the investor has all of the following: power

over the investee; exposure, or rights, to variable returns from its involvement with the investee; and

the ability to use its power over the investee to affect the amount of the investor’s returns. A funda-

mental consideration as to whether or not power exists is the extent of voting rights. Having more than

half of the voting power in another entity is normally regarded as having power. However, even if less

than 50 per cent of the voting power is held, an entity may still be regarded as controlling another entity

if it has powers to govern the financial and operating policies of the entity. For example, an entity may

have a number of its directors on the board of another entity and therefore may have majority voting

rights on the board of directors.

A group (also referred to as the economic entity) refers to the parent entity and all its subsidiaries.

The concept of a group is illustrated in figure 5.4. Entity A (the parent entity) owns 80 per cent of

Entity B, and controls Entity B via its majority share ownership. Hence, Entity B is regarded as a sub-

sidiary of Entity A and part of the group. Parent entity financial statements portray the financial position

of Entity A only, whereas the consolidated financial statements portray the financial position of the

group — both Entity A and Entity B. When preparing consolidated accounts, any transaction between

entities in the group is eliminated. For example, assume Entity A sells goods to the value of $250 000 to

Entity B. This is sales revenue for Entity A and the cost of sales for Entity B. When preparing the con-

solidated financial statements, such intercompany sales and purchases are eliminated. The sales for the

consolidated entity will not include the $250 000 of sales from Entity A to Entity B, and the $250 000 of

purchases by Entity B from Entity A will also be eliminated from the consolidated accounts.

Consolidated entity

Consolidated entity

financial statements

prepared

Parent entity financial

statements prepared

Entity A

(Parent entity)

Entity B

(Subsidiary entity)

80% share

ownership

FIGURE 5.4 Concept of parent entity and group