Question

Q4. Bill Handy, The finance director of Northern Australia Global Investments Ltd (NAGIL), is unsure whether he should consolidate some of the investments that the company owns. He has asked your advice as business adviser to NAGIL. The details of the investments are as follows:

(a) NAGIL had provided a loan to Struggle Ltd (SL) some years ago. When it looked as if SL would be unable to repay the loan it was converted into equity which gave NAGIL a 70% holding in SL. SL continues to have a substantial accumulated losses balance and the company’s results have been consolidated with NAGIL for some time. NAGIL does not take an active role in the day to day operations of SL as it has no directors on the board and it takes no part in the operating or financing decisions of the company.

(b) NAGIL has also provided a loan to the Very Big Company Ltd (VBCL). Unfortunately due to an industrial economic downturn the VBCL has failed to meet its loan repayments as required by the loan contract. The board of NAGIL is concerned that not only would the VBCL continue to have problems but also that the whole of the loan would become unrecoverable. The board of VBCL has agreed, as part of a bailout package, that NAGIL would take charge of VBCL’s finances for the next four years. The NAGIL deputy chief finance officer would control all payments made by VBCL and no payments would be made without prior approval. NAGIL does not have board representation on VBCL which is appointed by the VBCL shareholders.

(c) The Medium Sized Company Ltd (MSCL) is part funded by NAGIL, which owns 50% of the shares, and by Sharp Players Ltd (SPL) which owns the other 50%. The votes of the ordinary shares in the annual general meetings and the board representation are shared equally between NAGIL and SPL. SPL and NAGIL have agreed that NAGIL will provide the finance on a standard commercial basis with the loan being secured by a mortgage on MSCL’s property. The agreement also stipulates that SPL will provide the necessary managerial and entrepreneurial expertise in return for a management fee. The management fee will be paid out of ASCL’s net profits after providing for all NAGIL’s loan interest payments. Where MSCL does not make a profit the interest payments will still take place but no management fee will be paid.

(d) Tom and Marjory Legless are founders of CrocsRUs an adventure travel company. They both sit on the board and own 60 per cent of the shares. They have recently retired from actively running the company and have sold the other 40 per cent of the shares to NAGIL who manages the company on their behalf, holding the other three seats on the board. Although Tom and Marjory keep a close eye on the business they let NAGIL make the major decisions.

REQUIRED

Write a report to Bill, advising him how the control requirements of AASB 10 apply in each of the above investments. State, for each investment, where the control rests, citing and explaining how the relevant paragraphs of AASB10 apply, and whether Bill should include the results of the investments within the consolidated accounts explaining the reasons for your decision.

Answer 1

ANSWER:

AASB 10 Consolidated Financial Statements
AASB 10 Consolidated Financial Statements Provides guidance on determining whether the control over an entity exist or not and whether the entity must be consolidated or not.
Test of Control
To determine whether it controls an investee an investor shall assess whether it has all the followings: (Para 7 of AASB 10)
1. power over the investee ;
2. exposure, or rights, to variable returns from its involvement with the investee:
3. the ability to use its power over the investee to affect the amount of the investor’s returns
An investor with the current ability to direct the relevant activities has power even if its rights to direct have yet to be exercised. The investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power over the investee.
An investor can have power over an investee even if other entities have existing rights that give them the current ability to participate in the direction of the relevant activities
An investor is exposed, or has rights, to variable returns from itsinvolvement with the investee when the investor’s returns from its involvement have the potential to vary as a result of the investee’s performance.
An investor controls an investee if the investor not only has power over the investee and exposure or rights to variable returns from its involvement with the investee, but also has the ability to use its power to affect the investor’s returns from its involvement with the investee.
With reference to above provisions of Para 7 of AASB 10 , we shall discuss all 4cases as below.
1. Loan to Struggle Ltd by NAGIL
2. Conversion of loan into 70% holding of Struggle ltd. Does not by itself indicates that NAGIL has power over an investees. For an investor that holds more than half of the voting rights of an investee, to have power over an investee, the investor’s voting rights must be substantive, in accordance with paragraphs B22–B25, and must provide the investor with the current ability to direct the relevant activities, which often will be through determining operating and financing policies.
3. NAGIL does not take an active role in the day to day operations of SL as it has no directors on the board.
4. it takes no part in the operating or financing decisions of the company.
Conclusion
It can be concluded in case 1 that NAGIL has no control over the Struggle Ltd and hence NAGIL can not consolidate the Struggle Ltd while preparing it’s own financial statements.
5. Loan to Very Big Company Ltd (VBCL) by NAGIL
The board of VBCL has agreed, as part of a bailout package, that NAGIL would take charge of VBCL’s finances for the next four years.
The NAGIL deputy chief finance officer would control all payments made by VBCL and no payments would be made without prior approval.
Above facts of the case indicates to some extent NAGIL’s ability to use its power over the investee to affect the amount of the investor’s returns. But there is no power of NAGIL over VBCL since
Conclusion
It can be concluded in case 2 that NAGIL has no control over the VBCL and hence NAGIL can not consolidate the VBCL while preparing it’s own financial statements.
6. Medium sized company Ltd (MSCL) partly funded by NAGIL
The votes of the ordinary shares in the annual general meetings and the board representation are shared equally between NAGIL and SPL. SPL and NAGIL –so both have equal voting rights with tie in power.
SPL and NAGIL have agreed that NAGIL will provide the finance on a standard commercial basis with the loan being secured by a mortgage on MSCL’s property. The agreement also stipulates that SPL will provide the necessary managerial and entrepreneurial expertise in return for a management fee. – Managerial and entrepreneurial expertise is being provided in consideration of Management fees which indicates is a professional exercise, and NAGIL has no power to participate and affect the amount of return.
Conclusion
It can be concluded in case 3 that NAGIL has no control over the MSCL and hence NAGIL can not consolidate the MSCL while preparing it’s own financial statements.
CrocsRUs partly funded by NAGIL
Fact of the case
Tom and Marjory Legless are founders of CrocsRUs an adventure travel company. They both sit on the board and own 60 per cent of the shares.
They have recently retired from actively running the company and have sold the other 40 per cent of the shares to NAGIL who manages the company on their behalf, holding the other three seats on the board. Although Tom and Marjory keep a close eye on the business they let NAGIL make the major decisions.
In the given case NAGIL has operating decision making power only while not power over CrocsRU.
Conclusion
It can be concluded in case 4 that NAGIL has no control over the CrocsRu and hence NAGIL can not consolidate the CrocsRu while preparing it’s own financial statements.