Q9: How do we account for long-term investments that involve investing in the shares of other companies that are subsidiary companies?
For those situations where the investor company (parent) actually controls the investee company (subsidiary), we use the consolidation method. A parent controls a subsidiary ‘when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.” This is the case when a parent has more than 50% of the shares in an investee company. If a firm has 50% or less of the shares in an investee company, it is a matter of judgement whether the firm controls the investee company. When the consolidation method is used, consolidated financial statements are prepared for each of the four financial statements by ‘adding up’ the financial statements of each company in a group into a single set of consolidated financial statements:
“Consolidated financial statements are the financial statements of a group in which assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.”
AASB 128 para 3
There is a lot of complexity in adding together the financial statements of each company in a group into a single set of consolidated financial statements. A key thing to remember about this process is that during the year each company in a group will keep its own accounts, recording transactions as they come each day into its own separate accounts. If a subsidiary company is in a different country to its parent company it will, of course, keep its accounts in the currency of the country in which it is operating. For example, although Ryman Healthcare is based in New Zealand, its Australian subsidiaries keep their accounts in Australian dollars. It is only at balance date that the consolidated accounts of a group of companies (such as Ryman Healthcare) are prepared each year. When ‘adding’ together the accounts of companies in a group, the accounts of subsidiaries are changed into the currency of the parent (for example, NZ dollars for Ryman Healthcare) so the accounts of the companies can be added together in the same currency. This is the origin of ‘gains and losses arising from translating the financial statements of a foreign operation” as part of Other comprehensive income (see AASB101 Presentation of Financial Statements para 7 Other comprehensive income (c)).
Many other adjustments are made when the accounts of companies in a group are added together into consolidated accounts on balance date: inter-company transactions are eliminated (for example, sales and purchases between companies in the group), the equity of subsidiary companies owned by the parent in the group are eliminated and a wide range of other adjustments are made. You will have the opportunity to learn about this in detail in ACCT19061 Advanced Financial Accounting.
Also, see Martin’s videos Consolidation Method – Subsidiary Companies