Question

Case Study 8: Parent-subsidiary relationship (AASB10)

In the following independent situations, determine whether a parent–subsidiary relationship exists, and which entity, if any, is a parent.

1. Road Ltd is a company that was hurt by a major downturn in the economy. It previously obtained a significant loan from Wile E. Bank, and when Road Ltd was unable to make its loan repayments, the bank made an agreement with Road Ltd to become involved in the management of that company. Under the agreement between the two entities, Road Ltd’s managers had to obtain authority from the bank for acquisitions over $10 000 and were required to have bank approval for the company’s budgets.

2. Coyote Ltd is a major financing company whose interest in investing is return on the investment. Coyote Ltd does not get involved in the management of its investments. If an investee is not managed properly, Coyote Ltd sells its shares in that investee and selects a more profitable investee to invest in. It previously held a 35% interest in Tunes Ltd as well as providing substantial convertible debt finance to that entity. Recently, Tunes Ltd was having cash flow difficulties and persuaded Coyote Ltd to convert some of the convertible debt into equity so as to ease the effects of interest payments on cash flow. As a result, Coyote Ltd’s equity interest in Tunes Ltd increased to 52%. Coyote Ltd still wanted to remain as a passive investor, with no changes in the directors on the board of Tunes Ltd. These directors were appointed by the holders of the 48% of shares not held by Coyote Ltd.

Answer 1

Case 1:

A Investor will said to have control over Investee when Investor has 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

Here, in this case, the bank has Power over the Investee by way of involvement in the management but do not have right to variable returns it only have the right to recover the loan repayment but not full variable returns.

So, NO Parent-subsidary relationship Exists between the bank & Road Ltd.

Case 2:

A Investor will said to have control over Investee when Investor has 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

Here in the case, Coyote Ltd do not have power to change the Board of directors & do not hold power over Tunes Ltd.

So, NO Parent-subsidary relationship Exists between the Coyote Ltd. & Tunes Ltd.