Abstract
The current paper covers the financial statement presentation and disclosures. International Accounting Standards (IAS) 27 provides clear guidelines on when an entity has to consolidate its statements with another entity. The paper first identifies the four conditions needed while making presentations and disclosures of consolidated financial statements. One of the conditions is the company is not required but may present the consolidated financial statements if the parent is itself a wholly-owned subsidiary. The consolidated financial statements need to disclose the nature of the relationship between the parent and subsidiary to establish whether it is a direct or indirect relationship. In the context of off-balance sheet transactions, companies are required to make specific consolidated financial statements presentations and disclosures for the off-balance sheet transactions. The positive and negative implications of disclosures are also covered. Entities with high debt to equity ratio will be willing to disclose the off-balance sheet transactions. The process of accounting for variable interest entities is also covered in the paper.
International Accounting Standards (IAS) 27 provides clear guidelines on when an entity has to consolidate its statements with another entity, ways of accounting for a change in ownership interest, preparation of separate financial statements, and making the necessary disclosures. The current paper seeks to discuss the financial statements presentation and disclosures associated with consolidations concerning off-balance sheet transactions, variable interest entities, and non-controlling interest.
The parent company is required to present consolidated financial statements and any other disclosures whereby it consolidates all its investments in subsidiaries. However, the presentation and disclosure of consolidated financial statements are limited to four conditions. The company is not required but may present the consolidated financial statements if the parent is itself a wholly-owned subsidiary. Another condition is the parent equity instruments are not transacted in the public equity market. The third condition is the parent needs not to have filed its financial statements with the Securities Exchange Commission. Lastly, the intermediate parent should comply with the International Financial Reporting Standards (Cotter, 2012).
During the presentation of the consolidated financial statement, various disclosures need to be made. The consolidated financial statements need to disclose the nature of the relationship between the parent and subsidiary to establish whether it is a direct or indirect relationship. The statements should also disclose the reason for direct or indirect subsidiary relationship and the extent of any restrictions on the ability of the subsidiary to transfer money to the parent (Henry & Robinson, 2015). Finally, the reporting date of the financial statement of a subsidiary should be disclosed whenever it is different from the reporting date of the parent and the reason for the difference should be stated.
In the context of off-balance sheet transactions, companies are required to make specific consolidated financial statements presentations and disclosures for the off-balance sheet transactions. Off balance sheet, transactions are assets and liabilities that are not recorded in the entity’s balance sheet but are deferred. Such transactions allow the entity to enjoy the benefits of an asset whenever transferring its liabilities to another entity (Cotter, 2012). The liabilities incurred do not create equity. Therefore, they do not need to be recorded on the balance sheet. They include operating leases, capital leases, factoring, letters of credit or interest rates swaps. Companies are required to disclose all the off balance sheet transactions that are reasonably likely to have a current or future impact on the financial condition, revenues, expenses, liquidity or capital expenditure.
The disclosures in consolidated financial statements associated with the off balance sheet transactions have both positive and negative implications. The off-balance sheet disclosures in consolidated financial statements have a positive implication on the companies that are highly leveraged. Entities with high debt to equity ratio may face challenges in increasing their debt. Such companies will be willing to disclose the off-balance sheet transactions because it affects their debt positions positively (Barth, 2015). On the other hand, off balance sheet financing disclosures situations, such as operating leases and sale lease, have a negative impact on the liquidity ratio of an entity. Therefore, such disclosures should be avoided to ensure that the liquidity position of the entity is not affected. Sales lease arrangements that are off balance sheet lead to increase in liquidity level because the entity shows a large cash inflow from the sale and little nominal cash outflow for the rental expenses. Therefore, such disclosure will prevent the entity from fully maximizing on this advantage.
In the case of variable interest entities, the presentation of the consolidated financial statement and disclosures has some implications on the entities’ overall performance. A variable interest entity is an entity whereby the investor acquires less than the majority owned an interest in accordance with the United States Financial Accounting Standards Board. A variable interest entity needs to be presented in consolidated financial statements and disclosed (Cotter, 2012). For all the firms that are primary beneficiaries of the variable interest entities, the holding company should make all the necessary disclosures on the balance sheet about the ownership.
The guidelines for the process of accounting for variable interest entities is well outlined under the United States’ Generally Accepted Accounting Principles that provide the overall frameworks for the presentation of consolidated financial statements using the variable interest entities model (Henry & Robinson, 2015). The model requires the application of voting control based consolidation accounting models to make a meaningful financial presentation. According to the Financial Accounting Standards Board, the accounting model used to present the consolidated financial statements for the variable interest entities has to undergo significant changes to modify it to meet the requirements of the model (Henry & Robinson, 2015).
The consolidation of a variable interest entities is attained through the application of procedures similar to the consolidation of a majority-owned subsidiary based on the voting interests. The assets, liabilities, expenses, revenues, and the cash flows of the variable interest entities are presented in the consolidated financial statements of the primary beneficiary. The effect of removal of the variable interest entity’s income and expenses that arise from the transactions with the primary beneficiary is associated with the primary beneficiary but not the non-controlling interest (Weygandt, Kimmel & Kieso, 2015).
The disclosures about the variable interest entities are made to attain the main objectives of the necessary disclosures in the consolidated financial statements. The objectives are to make significant judgments on the reporting entity to determine whether to perform a consolidation of the variable interest entities financial statements or to disclose critical information about the involvement of the variable interest entities. Disclosures are also made on the nature of restrictions on a consolidated variable interest entity assets on the resettlement of its liabilities (Barth, 2015). Nature and changes in the risks associated with reporting entity involvement with the variable interest entity are also disclosed. The main disclosures made in the consolidated financial statements of variable interest entities are scope-related disclosures and aggregation of disclosures.
The disclosures made in the presentation of consolidated financial statements concerning variable interest entities have some positive and negative implications. The disclosure ensures that all the variable interest entities subsections are applied and in the case of failure to apply them, a reason for why the information is required applies. However, the methodology of determining whether the reporting entity is the beneficiary of variable interest entities is based on some assumptions whose disclosures may affect the relationship between the variable interest entity and the primary beneficiary (Weygandt, Kimmel & Kieso, 2015). In the long run, the disclosures of the consolidated financial statements of the variable interest entities are quite significant in ensuring the credibility of the financial statements is maintained.
In the case of the non-controlling interest, the presentation of consolidated financial statements and relevant disclosures are considered very critical consolidation processes. The non-controlling interest entails the portion of equity in a subsidiary that is not attributable either directly or indirectly to the parent company. The non-controlling interest can also be termed as minority interest because it has little significance in the overall performance of the parent company. According to the United States Financial Accounting Standards Board, the non-controlling interest shall be reported in the entities’ consolidated statements of financial position of the net assets but separately from the parents’ net assets (Bertomeu & Magee, 2015). The amount of the net assets for the subsidiary should be clearly indicated as the non-controlling interest in subsidiaries. Therefore, any entity with non-controlling interests in more than one subsidiary may be required to present the aggregate interests in the consolidated financial statements for the parent.
When the parent entity financial statements are presented but, in reality, they are not the primary financial statements, the reporting entities are required to make some disclosures in the form of notes for the financial statements. The disclosure requirements provide that the portion of consolidated net income and comprehensive income should be attributed to both the parent and the non-controlling interest (Henry & Robinson, 2015). The disclosure has a positive implication because it appreciates the contribution of the parent and non-controlling interest towards the overall income. Another disclosure requirement is that the amounts attributable to the non-controlling interest of income from continuous operations, discontinued operations, extraordinary operations, and other components of comprehensive income should be disclosed.
Besides, the reconciliation of the changes in reported amounts of non-controlling interest in the consolidated income is attributed to the non-controlling interest, investments to the non-controlling interest, and every component of the comprehensive income. The final disclosure entails a footnote in the financial statements to show the effects of transactions of the non-controlling interest, and it may have a negative implication on the amount of equity attributable to the non-controlling interest (Bertomeu & Magee, 2015).
References
Barth, M. E. (2015). Commentary on prospects for global financial reporting. Accounting Perspectives, 14(3), 154-167.
Bertomeu, J., & Magee, R. P. (2015). Mandatory disclosure and asymmetry in financial reporting. Journal of Accounting and Economics, 59(2), 284-299.
Cotter, D. (2012). Advanced financial reporting: A complete guide to IFRS. Financial Times/Prentice Hall.
Henry, E., & Robinson, T. R. (2015). Chapter 1. Financial statement analysis: An introduction. CFA Institute Investment Books, 2015(2), 1-35.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & managerial accounting. New Jersey: John Wiley & Sons.
