3.1.1 Exemptions from preparing consolidated financial statements

As well as various rules on exclusion of particular subsidiaries from consolidation (see 3.4 below), there are a number of provisions which exempt parent companies from having to prepare consolidated financial statements at all. Most of these exemptions replicate those permitted under the CA 2006 and specific reference is made by Section 9 to the legislation.

A parent is exempt from the requirement to prepare consolidated financial statements on any one of the following grounds: [FRS 102.9.3]

• When its immediate parent is established under the law of a European Economic Area (EEA) (see 3.1.1.A below):
  • The parent is a wholly-owned subsidiary. Exemption is conditional on compliance with certain further conditions set out in section 400(2) of the CA 2006.
  • The immediate parent holds 90% or more of the allotted shares in the entity and the remaining shareholders have approved the exemption. Exemption is conditional on compliance with certain further conditions set out in section 400(2) of the CA 2006.
  • The immediate parent holds more than 50% (but less than 90%) of the allotted shares of the entity, and notice requesting the preparation of consolidated financial statements has not been served on the entity by shareholders holding in aggregate at least 5% of the allotted shares in the entity (such notice must be served at least six months before the end of the financial year to which it relates). [s400(1)(c)]. Exemption is conditional on compliance with certain further conditions set out in section 400(2) of the CA 2006.
• When its parent is not established under the law of an EEA State (see 3.1.1.B and 3.1.1.C below):
  • The parent is a wholly-owned subsidiary. Exemption is conditional on compliance with certain further conditions set out in section 401(2) of the CA 2006.
  • The parent holds 90% or more of the allotted shares in the entity and the remaining shareholders have approved the exemption. Exemption is conditional on compliance with certain further conditions set out in section 401(2) of the CA 2006.
  • The parent holds more than 50% (but less than 90%) of the allotted shares of the entity, and notice requesting the preparation of consolidated financial statements has not been served on the entity by shareholders holding in aggregate at least 5% of the allotted shares in the entity (such notice must be served at least six months before the end of the financial year to which it relates). [s401(1)(c)]. Exemption is conditional on compliance with certain further conditions set out in section 401(2) of the CA 2006.
• The parent, and the group headed by it, qualify as small as set out in section 383 of the CA 2006 and are considered eligible for the exemption as determined by reference to sections 384 and 399(2A)-(2B) of the CA 2006 (see 3.1.1.D below).
• All of the parent's subsidiaries are required to be excluded from consolidation by section 402 of the CA 2006 (see 3.1.1.E below).
• For a parent not reporting under the CA 2006, if its statutory framework does not require the preparation of consolidated financial statements (see 3.1.1.F below).

When an immediate parent (section 400) or parent (section 401) holds more than 90% but less than 100% of the allotted shares the wording above implies that all the other shareholders must approve the exemption from preparing consolidated financial statements otherwise the exemption cannot be applied. Neither section 400 nor section 401 explain the form of the approval required.

For this purpose, shares held by a wholly-owned subsidiary of the parent or held on behalf of the parent undertaking or a wholly-owned subsidiary, should be attributed to the parent undertaking. [s400(3), s401(3)]. Shares held by directors of a company for the purpose of complying with any share qualification requirement should be disregarded for determining for the purposes of this section whether the company is a wholly-owned subsidiary. [s400(5), s401(5)].

The term ‘allotted shares’ is not restricted and includes all classes of shares and not just ordinary shares or voting shares, including shares that are classified as a liability under FRS 102 (see Chapter 10 at 5.2). The term ‘allotted shares’ rather than ‘allotted share capital’ suggests that it is the number of shares rather than their monetary amount which should be considered although this is not clear.

The exemptions in respect of sections 400 and 401 of CA 2006 referred to above do not apply if any of the parent's transferable securities are admitted to trading on a regulated market of any EEA State within the meaning of EC Directive 2014/65/EC (i.e. a ‘traded company’ as defined by section 474(1) of CA 2006). [FRS 102.9.3]. This requirement repeats a restriction already contained within both sections 400 and 401 although not within sections 400(2) and 401(2) referred to above. [s400(4), s401(4)].

3.2.1 Potential voting rights

Control can be achieved by having options or convertible instruments that are currently exercisable. [FRS 102.9.6]. These instruments may be shares, warrants, share call options, debt or equity instruments that are convertible into instruments that have the potential, if exercised or converted, to give the entity power or reduce another party's voting power over the financial and operating policies of another entity.

The existence and effect of potential voting rights must be considered when assessing whether an entity has the power to govern the financial and operating policies of another entity so as to obtain benefits from its activities. When an option to acquire a controlling interest in an entity has not yet been exercised, but can be freely exercised by its holder (that is, it could be exercised and, if exercised, would give the holder control) the holder in effect has the power of veto and has the power to govern the entity's financial and operating policies.

Potential voting rights are not currently exercisable or convertible when they cannot be exercised or converted until a future date or until the occurrence of a future event. Example 8.2 illustrates the meaning of currently exercisable.

An entity must exercise judgement when determining whether potential voting rights are currently exercisable. A literal reading might suggest that unless the potential voting right is exercisable immediately, the entity ignores the potential voting right when assessing control. In practice, however, many potential voting rights are not exercisable immediately but rather only exercisable after giving notice (e.g. options over the shares of unlisted entities often include a notice period of several days or a week). In practice, a short notice period is usually ignored when assessing whether the rights are currently exercisable.

FRS 102 provides no guidance on whether the intention of management or the financial ability to exercise or convert a potential voting right are factors that must be considered in assessing whether those rights give control. In the absence of guidance, under the hierarchy in Section 10 – Accounting Policies, Estimates and Errors – an entity could look to the requirements and guidance in EU-adopted IFRS relating to similar issues. In this case, there are two possible sources of reference, IFRS 10 (the extant standard) and IAS 27 (2012) (the standard on which much of Section 9's control model is based). Both IFRS 10 and IAS 27 (2012) are clear that the intention of management should be ignored in assessing whether potential voting rights give control. [IFRS 10 Appendix B.22, IAS 27.15 (2012)]. In respect of the financial ability to exercise or convert a potential voting right, IFRS 10 states that the financial ability of an investor to pay the exercise price should be considered when evaluating whether an option is substantive. [IFRS 10 Appendix B.23(a)]. In contrast, IAS 27 (2012) stated that the financial ability to exercise or convert a potential voting right is not considered in assessing control. [IAS 27.15 (2012)].

3.2.2 Control exercised through an agent

Control can be achieved by having an agent with the ability to direct the activities for the benefit of the controlling entity. [FRS 102.9.6].

The overall relationship between the investor and the agent must be assessed to determine whether the ‘agent’ is acting as an agent for the controlling entity or as a principal in its own right.

3.2.3 Interests held as trustee or fiduciary, or as security

A reporting entity may hold, as a trustee or fiduciary on behalf of others, an interest in another entity that either on its own or when combined with any interest held on its own account, gives the reporting entity control of the majority of the voting rights in, or the ability to appoint or remove a majority of the members of the board of the other entity. This raises the question of whether that other entity is controlled by the reporting entity.

In our view, interests held in another entity on behalf of others generally do not give a reporting entity control over that other entity. Control is ‘the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities’ (emphasis added). [FRS 102.9.4]. A trustee or other fiduciary exercises any decision-making powers relating to assets under its management so as to obtain benefits not for itself, but for those on whose behalf it exercises the powers. The CA 2006 states that rights held by a person in a fiduciary capacity shall be treated as not held by that person. Similarly, rights held by a person as nominee for another (if such rights are exercisable only on that other person's instructions or with that other person's consent or concurrence), are regarded as held by the other. [7 Sch 6-7, 9(2)-(3)].

Rights attached to shares by way of a security are normally treated as held by the person providing the security if, apart from the ability to exercise them for the purpose of preserving the value of the security, rights are only exercisable upon that person's instructions. The same applies when shares are held in connection with the granting of loans as part of normal business activities. [7 Sch 8, 9(2)-(3)].

Rights are treated as held by a parent undertaking if they are held by any of its subsidiary undertakings. [7 Sch 9(1)].

As illustrated in Example 8.3, consolidation is still required if an entity legally owns and controls an investment, even if the risks and rewards have been passed on to a third party. Determining whether an entity controls an investment or merely holds an interest in a fiduciary capacity requires a careful assessment of the facts and circumstances.

3.2.4 De facto control

De facto control over an entity by a minority shareholder (e.g. a shareholder holding less than a majority of the voting rights) may arise in a number of ways. A common example is when other shareholders are widely dispersed, and when a sufficient number of other shareholders regularly fail to exercise their rights as shareholders (e.g. to vote at general meetings), such that the minority shareholder wields the majority of votes actually cast.

De facto control is not specifically addressed by FRS 102. In our view, FRS 102 does not necessarily require consolidation of entities subject only to de facto control since the definition of control refers to the power to govern the financial and operating policies of an entity and power is explained as representing the ability to do or effect something, whether actively or passively (see 3.2 above). It follows from the definition that control involves the ability:

• to make decisions without the support or consent of other shareholders; and
• to give directions with respect to the operating and financial policies of the entity concerned, with which directions the entity's directors are obliged to comply.

Accordingly, control does not exist where an investor must obtain the consent of one or more other shareholders in order to govern the operating and financial policies of the investee.

To have the ability to govern the financial and operating policies of an entity, an investor must be able to hold the management of the entity accountable. It is therefore unlikely that de facto control over an entity can exist unless the investor has the power to appoint and remove a majority of its governing body (i.e. normally the board of directors in the case of a company). This power is normally exercisable by holders of the voting shares in general meeting.

In practice, de facto control is most likely to be evidenced where an investor with less than a 50% voting interest is able to have its chosen candidates (re)nominated for election to an entity's board of directors and its votes exceed 50% of the votes typically cast in the entity's election of directors. For example, if typically only 70% of the eligible votes are cast on resolutions for the appointment of directors, a minority holding of 40% might give de facto control if the remaining shares are widely held (for example, no party has an interest of sufficient size either of itself or with a small number of others, to block decisions).

The question also arises as to whether de facto control can exist where a minority voting interest represents less than 50% of votes typically cast in elections of directors, for example, a voting interest of 30% where, typically, 70% of the eligible votes are cast in elections. It is highly unlikely that de facto control exists in this case. As control is unilateral, when assessing whether de facto control exists, the entity does not consider the possibility that other shareholders will cast their votes in the same way as the entity.

The determination of whether de facto control exists is based on facts and circumstances. It is unlikely to be sufficiently certain that de facto control exists until actions taken provide evidence of control – i.e. control must be actively exercised. In general, the more that the legal or contractually-based powers that are held in relation to an entity fall short of 50% of the total powers, the greater is the need for evidence of actively exercised de facto control.

3.3.1 Benefits need not necessarily be financial

As discussed at 3.3 above, the first of the indicators of whether an entity is an SPE is that its activities are being conducted on behalf of the reporting entity according to its specific business needs.

In our view, this indicator does not necessarily require that the reporting entity has any direct financial benefit. The ‘benefit’ might be the avoidance of negative outcomes, or operational benefits.

3.3.2 Majority of the benefits and risks

In our view, the reference to the majority of benefits and risks in the third and fourth indicators at 3.3 above refer to the majority of benefits and risks that are likely to arise in practice, rather than to the majority of all theoretically possible benefits and risks as illustrated by Example 8.4.

3.3.3 Subsequent reassessment of control of an SPE

FRS 102 is silent on whether an entity must reassess who controls an SPE after inception. In our view, the basic principles of consolidation must be considered. Consolidation is required when there is control. Ordinarily, for an SPE, one would not expect changes in control after inception. However, in our view, reassessing whether a reporting entity continues to control an SPE is required when:

1. there is a change in the contractual arrangements between the parties to the SPE; or
2. any of the parties take steps to strengthen its position and, in doing so, acquires a greater level of control.

Reassessment of which party controls an SPE is a difficult issue; each situation must be assessed based on the facts and circumstances.

An example of the situation in (b) is that if in a period of financial difficulty, commercial paper cannot be reissued for longer than a certain period, the agreement governing the structure may require the assets to be liquidated. The liquidity provider, knowing that a sale of the assets in that difficult environment is likely to result in losses, might decide to extend the life of the structure by buying the new issue of commercial paper. This was not an action that was anticipated in the original agreement and may mean that the liquidity provider has changed the relative contractual positions of the parties to the SPE and taken effective control.

So long as the initial control assessment is not called into question (e.g. because it was based on incomplete or inaccurate information), subsequent changes in the relationship due to changes in the risk profile, or market events, do not necessarily mean that there has been any transfer of control between the parties. For example, the impairment of the assets owned by an SPE would not necessarily trigger reassessment. Similarly, if the losses incurred by an SPE exceed the capital provided to it, such that the residual risk now lies with another party, (for example the SPE sponsor), this event alone would not necessarily trigger reassessment. However, when events such as these occur, the party bearing the residual risk often takes steps to protect its position, which in turn might trigger a reassessment of whether that party controls the SPE and therefore consolidates the SPE.

3.3.4 Securitisation transactions

SPEs are most commonly found in, but are not unique to, the financial services sector, where they are used as vehicles for securitisation of financial assets such as mortgages or credit card receivables. The effect of these requirements combined with the derecognition provisions of Section 11 – Basic Financial Instruments – may be that:

• a securitisation transaction qualifies as a sale of the financial asset concerned (which is thus, in principle, derecognised, or removed from the financial statements); but
• the ‘buyer’ is an SPE, so that the asset is immediately re-recognised through consolidation of the SPE.

3.4.1 Subsidiaries excluded from consolidation due to severe long term restrictions

A subsidiary excluded from consolidation because severe long-term restrictions substantially hinder the exercise of the rights of the parent over the assets or management of the subsidiary is accounted for in the consolidated financial statements as if it is an investment in a subsidiary in separate financial statements using an accounting policy choice selected by the parent (i.e. either at cost less impairment, at fair value with changes in fair value recognised through other comprehensive income (or profit or loss to the extent that it reverses revaluation movements in profit or loss or where the revaluation reserve would otherwise be negative), or at fair value with changes in fair value recognised in profit and loss – see 4.2 below). [FRS 102.9.26]. However, if the parent still exercises a significant influence over the subsidiary it should be treated as an associate using the equity method in the consolidated financial statements. [FRS 102.9.9B]. In our view, consistent with the requirements for disposal where control is lost (see 3.6.3 below), the initial cost of the investment in the subsidiary in these circumstances should be the carrying amount of the net assets (and goodwill) attributable to the investment on the date that the severe long term restrictions affected the parent's exercise of its rights over the subsidiary. [FRS 102.9.19].

A true and fair override may be required for subsidiaries excluded from consolidation that are held at fair value through profit or loss as this accounting is not permitted by the CA 2006 in circumstances where this would not be permitted by IFRS 10. [FRS 102 Appendix III.17, 1 Sch 36].

FRS 102 does not provide any examples of situations in which a subsidiary might be subject to severe long term restrictions that hinder the exercise of the parent's rights over the assets or management of the subsidiary. However, examples might include:

• insolvency or administration of the subsidiary; or
• veto powers held by a third party (e.g. powers held by a lender due to covenant breaches); or
• the existence of severe restrictions over remittance of funds (e.g. dividends) if they prevent the parent from obtaining benefits of the subsidiary.

FRS 102 provides no guidance as to the accounting if the severe long-term restrictions cease and the parent's rights are restored. In our view, consistent with the guidance contained in previous UK GAAP, when the severe long-term restrictions cease and the parent's rights are restored, the amount of the unrecognised profit or loss that accrued during the period of restriction for that subsidiary should be separately disclosed in the consolidated profit and loss account of the period in which control is resumed. Similarly, any amount previously charged for impairment that needs to be written back as a result of restrictions ceasing in profit or loss in the period in which control is resumed should be separately disclosed. [FRS 2.28]. This is different from the accounting for a subsidiary in which control has been lost whereby the regaining of control would be treated as a business combination achieved in stages (a step acquisition) under Section 19 – Business Combinations and Goodwill (see Chapter 17 at 3.11).

3.4.2 Subsidiaries held exclusively with a view to subsequent resale

A subsidiary held exclusively with a view to subsequent resale is an interest: [FRS 102 Appendix I]

• for which a purchaser has been identified or is being sought, and which is reasonably expected to be disposed of within approximately one year of its date of acquisition; or
• that was acquired as a result of the enforcement of a security, unless the interest has become part of the continuing activities of the group or the holder acts as if it intends the interest to become so; or
• which is held as part of an investment portfolio (see 3.4.2.A below).

For a subsidiary to be classified as held exclusively with a view to subsequent resale it must not have been consolidated previously in consolidated financial statements prepared under FRS 102. [FRS 102.9.9(b)].

A subsidiary excluded from consolidation on the grounds that is held exclusively for resale is accounted for in the consolidated financial statements as follows: [FRS 102.9.9C]

• a subsidiary held as part of an investment portfolio is measured at fair value with changes in fair value recognised in profit or loss; and
• a subsidiary not held as part of an investment portfolio is accounted for as if it was an investment in a subsidiary in separate financial statements (i.e. either at cost less impairment, at fair value with changes in fair value recognised in other comprehensive income (or profit or loss to the extent that it reverses revaluation movements in profit or loss or where the revaluation reserve would otherwise be negative) or at fair value with changes in fair value recognised in profit or loss – see 4.2 below).

A true and fair override may be required for subsidiaries excluded from consolidation that are held at fair value through profit or loss (whether or not these are subsidiaries held as part of an investment portfolio) as this accounting is not permitted by the CA 2006 in circumstances where this would not be permitted by IFRS 10. [FRS 102 Appendix III.17, 1 Sch 36].

FRS 102 provides no guidance as to the accounting if a subsidiary is no longer considered to be held exclusively with a view to subsequent resale. In our view, the subsidiary should be consolidated from the date of the change in circumstances using the fair values of the identifiable assets and liabilities of the subsidiary at the date of the original acquisition with a catch-up adjustment to reflect subsequent movements to the date that the subsidiary is no longer held exclusively with a view to subsequent resale. This is because the subsidiary has always been controlled by the parent from the date of the original acquisition. This is also consistent with the requirement in the Regulations that identifiable assets and liabilities acquired must be included in the consolidated balance sheet at their fair values at the date of the acquisition. [6 Sch 9].

3.4.3 Limited partnerships

A limited partnership is made up of one or more ‘general partners’ and one or more ‘limited partners’. Limited partnerships which are ‘Qualifying Partnerships’ are required to prepare statutory financial statements in accordance with the CA 2006. FRS 102 has no specific consolidation guidance for limited partnerships. Under the Limited Partnership Act 1907, a limited partner is prevented from taking an active role in the affairs of the entity. Therefore, where a company is the sole general partner of a limited partnership, the limited partnership may meet the definition of a subsidiary (see 3.2 above). However, the general partner's investment in a limited partnership is often only nominal in amount and the funding is often provided by the limited partners.

Therefore, determining whether the general partner should consolidate a limited partnership requires judgement and consideration of the facts and circumstances. One situation which might indicate that the limited partnership should be consolidated is where there are guarantees given by the limited partnership which might, if called, fall due to the general partner because the general partner will potentially be subject to majority of risks of the partnership. One situation where the definition of a subsidiary may not be met is where the general partner can be dismissed without cause by the limited partner.

3.5.1 Intragroup balances and transactions

Intragroup balances and transactions, including income, expenses and dividends must be eliminated in full. Profits and losses resulting from intragroup transactions that are recognised in assets, such as inventory and property, plant and equipment, must also be eliminated in full. [FRS 102.9.15]. Example 8.6 below illustrates this.

Even though losses on intragroup transactions are eliminated in full, they may still indicate an impairment, under Section 27 – Impairment of Assets, that requires recognition in the consolidated financial statements. [FRS 102.9.15]. For example, if a parent sells a property to a subsidiary at fair value and this is lower than the carrying amount of the asset, the transfer may indicate that the property (or the cash-generating unit to which that property belongs) is impaired in the consolidated financial statements. This will not always be the case as the asset's value-in-use may be sufficient to support the higher carrying value. See Chapter 24 at 4.1.

Intragroup transactions give rise to a tax expense or benefit in the consolidated financial statements under Section 29 – Income Tax – which applies to timing differences that arise from the elimination of profits and losses arising from intragroup transactions. [FRS 102.9.15]. See Chapter 26 at 6.1.

3.5.2 Uniform reporting dates and reporting period

The directors of a parent company have an obligation under the CA 2006 to secure that, except where in their opinion there are good reasons against it, the financial year of each of its subsidiary undertakings coincides with the company's own financial year. [s390(5)].

Similarly, FRS 102 states that the financial statements of the parent and its subsidiaries used in the preparation of consolidated financial statements shall be prepared as of the same reporting date, and for the same reporting period, unless it is impracticable to do so. [FRS 102.9.16]. Impracticability is discussed in Chapter 9 at 3.1.

When the reporting date and reporting period of a subsidiary are not the same as the parent's reporting date and reporting period, the consolidated financial statements must be made up: [FRS 102.9.16]

• from the financial statements of the subsidiary as of its last reporting date before the parent's reporting date, adjusted for the effects of significant transactions or events that occur between the date of those financial statements and the date of the consolidated financial statements, provided that the reporting date is no more than three months before that of the parent; or
• from interim financial statements prepared by the subsidiary as at the parent's reporting date.

This is consistent with the requirements of the Regulations. [6 Sch 2(2)].

3.5.3 Uniform accounting policies

Consolidated financial statements must be prepared using uniform accounting policies for like transactions and other events and conditions in similar circumstances. Therefore, if a member of the group uses accounting policies other than those adopted in the consolidated financial statements for like transactions and events in similar circumstances, appropriate adjustments are to be made to its financial statements in preparing the consolidated financial statements. [FRS 102.9.17].

However, as an exception to this rule, using non-uniform accounting policies for insurance contracts (and related deferred acquisition costs and related intangible assets, if any) is permitted if this is a continuation of an accounting policy used under previous GAAP. [FRS 103.2.6(c)].

Other than for insurance contracts, non-uniform accounting policies are not permitted (unless the directors invoke a true and fair override) by FRS 102. The Regulations are more lenient and allow non-uniform accounting policies if it appears to the directors that there are special reasons for it and these reasons and their effect are disclosed – but an entity must comply with both FRS 102 and the Regulations. [6 Sch 3(2)].

3.5.4 Consolidating foreign operations

Section 9 does not specifically address how to consolidate subsidiaries that are foreign operations. Section 30 – Foreign Currency Translation – states that when a group contains individual entities with different functional currencies, the items of income and expense and financial position of each entity are expressed in a common currency so that consolidated financial statements may be presented. [FRS 102.30.17]. No preference is stated as to whether the financial statements of a foreign operation are translated directly into the presentation currency of the group (known as the direct method) or translated into the functional currency of any intermediate parent and then translated into the presentation currency of the group (known as the step-by-step method). In our view, either method is acceptable provided it is applied consistently.

In incorporating the assets, liabilities, income and expenses of a foreign operation with those of the reporting entity, normal consolidation procedures are followed, such as the elimination of intragroup balances and intragroup transactions. However, an intragroup monetary asset, whether short-term or long-term, cannot be eliminated against the corresponding intragroup liability (or asset) without showing the results of the currency fluctuations in the consolidated financial statements which must be reflected in either profit or loss or other comprehensive income as appropriate. [FRS 102.30.22].

3.6.1 Accounting for an acquisition where control is achieved in stages

When a parent acquires control of a subsidiary in stages, Section 9 refers to the requirements of paragraphs 11A and 14 of Section 19, applied at the date control is achieved. [FRS 102.9.19B]. This means that when control is achieved in stages, the cost of the business combination is the aggregate of the fair values of the assets given, liabilities assumed and the equity instruments issued by the acquirer at the date of each transaction in the series. [FRS 102.19.11A]. See Chapter 17 at 3.11.

3.6.2 Accounting for an increase in a controlling interest in a subsidiary

When a parent increases its controlling interest in a subsidiary, the identifiable assets and liabilities and a provision for contingent liabilities of the subsidiary are not revalued to fair value and no additional goodwill is recognised at the date the controlling interest is increased. [FRS 102.9.19C].

The transaction is accounted for as a transaction between equity holders and accordingly the non-controlling interest shall be adjusted to reflect the change in the parent's interest in the subsidiary's net assets and any difference between the amount by which the non-controlling interest is so adjusted and the fair value of the consideration paid is recognised directly in equity and attributed to equity holders of the parent. No gain or loss is recognised on these changes in equity. [FRS 102.9.19D, 22.19]. Example 8.7 illustrates the accounting for increasing a controlling interest in a subsidiary.

The guidance on reattribution of items of other comprehensive income and accounting for transaction costs discussed at 3.6.4 below apply here also.

3.6.3 Accounting for a disposal of a subsidiary when control is lost

When a parent ceases to control a subsidiary, a gain or loss is recognised in the consolidated statement of comprehensive income (or in the income statement if presented) calculated as the difference between: [FRS 102.9.18A]

• the proceeds from the disposal (or the event that resulted in the loss of control); and
• the proportion of the carrying amount of the subsidiary's net assets, including any related goodwill, disposed of (or lost) as at the date of disposal (or date control is lost).

The gain or loss calculated above shall also include those amounts that have been recognised in other comprehensive income in relation to that subsidiary, where those amounts are required to be reclassified to profit or loss upon disposal in accordance with other sections of FRS 102. Amounts that are not required to be reclassified to profit or loss upon disposal of the related assets or liabilities in accordance with other sections of FRS 102 are transferred directly to retained earnings. [FRS 102.9.18B].

The cumulative amount of any exchange differences that relate to a foreign subsidiary recognised in equity in accordance with Section 30 is not recognised in profit or loss as part of the gain or loss on disposal of the subsidiary and is transferred directly to retained earnings. [FRS 102.9.18A].

FRS 102 permits only the following unrealised gains and losses recognised in other comprehensive income to be recycled through profit or loss upon disposal of a subsidiary:

• unrealised gains and losses on available-for-sale (AFS) investments (if the entity has elected to use IAS 39 – Financial Instruments: Recognition and Measurement – for recognition and measurement of financial instruments); [FRS 102.11.2(b), 12.2(b)]
• unrealised gains and losses on debt instruments at fair value through other comprehensive income (if the entity has elected to use IFRS 9 for recognition and measurement of financial instruments); [FRS 102.11.2(c), 12.2(c)]
• unrealised gains and losses on cash flow hedges (except for the portion attributable to a hedge of a net investment in a foreign operation); [FRS 102.12.23-24] and
• unrealised gains and losses arising from the application of shadow accounting for insurance contracts. [FRS 103.2.11].

No other unrealised gains and losses that have been recognised in other comprehensive income are recycled upon disposal of a subsidiary.

If an entity ceases to be a subsidiary but the former parent continues to hold:

• an investment that is not an associate or a jointly controlled entity, that investment shall be accounted for as a financial asset in accordance with Section 11 or Section 12 (see Chapter 10) from the date the entity ceases to be the subsidiary;
• an associate, that associate shall be accounted for in accordance with Section 14 (see Chapter 12); or
• a jointly controlled entity, that jointly controlled entity shall be accounted for in accordance with Section 15 (see Chapter 13).

The carrying amount of the net assets (and goodwill) attributable to the investment at the date that the entity ceases to be a subsidiary shall be regarded as cost on initial measurement of the financial asset, investment in associate or jointly controlled entity, as appropriate. In applying the equity method to investments in associate or jointly controlled entities as required above, the requirements in respect of the recognition of implicit goodwill and fair value adjustments (see Chapter 12 at 3.3.2.D), shall not be applied. [FRS 102.9.19].

Example 8.8 below illustrates the accounting for a disposal of a subsidiary:

A deemed disposal that results in loss of control of a subsidiary is accounted for as a regular disposal. This is illustrated in Example 8.9 below.

3.6.4 Accounting for a part disposal of a subsidiary when control is retained

Where a parent reduces its holding in a subsidiary and control is retained, it shall be accounted for as a transaction between equity holders and the carrying amount of the non-controlling interest shall be adjusted to reflect the change in the parent's interest in the subsidiary's net assets. Any difference between the amount by which the non-controlling interest is so adjusted and the fair value of the consideration paid or received, if any, shall be recognised directly in equity and attributed to equity holders of the parent. No gain or loss shall be recognised at the date of disposal and the entity shall not recognise any change in the carrying amount of assets (including goodwill) or liabilities as a result of the transaction. [FRS 102.9.19A, 22.19].

FRS 102 is not clear whether a portion of goodwill should be regarded as now being attributable to the non-controlling interest in computing the difference to be taken to equity in these circumstances. However, we believe the most logical treatment is that the parent should reallocate a proportion of the goodwill between controlling and non-controlling interest when there is a decrease in the parent's ownership interest without loss of control. Otherwise, any gain or loss recognised upon a subsequent loss of control or goodwill impairment would not reflect the ownership interest applicable to that non-controlling interest.

Example 8.10 below illustrates the accounting for a disposal where control is retained.

FRS 102 is silent as to whether amounts recognised in other comprehensive income and equity should be reattributed when a change in ownership in a subsidiary occurs that does not result in the loss of control. In our view, it is logical that such a reattribution should occur and this is consistent with Section 30 which requires that the accumulated exchange differences arising from translation which relate to a foreign operation that is consolidated but not wholly-owned that are attributable to the non-controlling interest are allocated to, and recognised as part of, non-controlling interest. [FRS 102.30.20].

Although FRS 102 is clear that changes in a parent's ownership interest in a subsidiary that do not result in loss of control of the subsidiary are equity transactions, it does not specifically address how to account for related transaction costs. In our view, any directly attributable costs incurred to sell a non-controlling interest in a subsidiary without loss of control are deducted from equity. Whether the costs are attributable to the parent or to the non-controlling interest depends on whether the costs have been incurred by the parent (in which case the costs are attributable to parent equity) or the subsidiary with the non-controlling interest (in which case the cost would be allocated between parent equity and non-controlling interest based on their respective shares).

3.8 Exchanges of businesses or other non-monetary assets for an interest in a subsidiary, jointly controlled entity or associate

A reporting entity may exchange a business, or other monetary asset, for an interest in another entity, and that other entity becomes a subsidiary, jointly controlled entity or associate of the reporting entity. The accounting issues that arise from these transactions are whether they should be accounted for at fair value or at previous book values and how the gain on the transaction should be reported.

The principles behind the requirements for these transactions (derived from previous UK GAAP) are that the only exception to the use of fair values should be in rare circumstances where the transaction is artificial and has no substance and that any unrealised gains should not be reported in profit or loss.

Accordingly, the following accounting treatment applies in the consolidated financial statements of the reporting entity: [FRS 102.9.31]

• to the extent that the reporting entity retains an ownership interest in the business, or other non-monetary assets, exchanged, even if that interest is then held through another entity, that retained interest, including any related goodwill, is treated as having been owned by the reporting entity throughout the transaction and should be included at its pre-transaction carrying amount;
• goodwill is recognised as the difference between:
  • the fair value of the consideration given; and
  • the fair value of the reporting entity's share of the pre-transaction identifiable net assets of the other entity.

    The consideration given for the interest acquired in the other entity will include that part of the business, or other non-monetary assets, exchanged and no longer owned by the reporting entity. The consideration may also include cash or monetary assets to achieve equalisation of values. Where it is difficult to value the consideration given, the best estimate of its value may be given by valuing what is acquired;

• to the extent that the fair value of the consideration received by the reporting entity exceeds the carrying value of the part of the business, or other non-monetary assets exchanged and no longer owned by the reporting entity, and any related goodwill together with any cash given up, the reporting entity should recognise a gain. Any unrealised gain arising on the exchange is recognised in other comprehensive income; and
• to the extent that the fair value of the consideration received by the reporting entity is less than the carrying value of the part of the business, or other non-monetary assets no longer owned by the reporting entity, and any related goodwill, together with any cash given up, the reporting entity should recognise a loss. The loss should be recognised as an impairment in accordance with Section 27 or, for any loss remaining after an impairment review of the relevant assets, in profit or loss.

The accounting treatment can be illustrated in Examples 8.12 and 8.13 below:

The gain on the transaction in Example 8.12 is unrealised because qualifying consideration has not been received. Therefore, the gain is accounted for in other comprehensive income as only realised profits can be recognised in profit or loss. Where part or all of the gain is realised then that portion can be taken to profit and loss. This is illustrated in Example 8.13 below:

FRS 102 does not explain how a realised gain can be distinguished from an unrealised gain. In Example 8.13 above, we have used a ‘top slicing’ approach whereby as much as the total gain as is backed by net cash is treated as realised (i.e. £5m). ‘Top slicing’ is the recommended approach to determining realised profits for exchanges of assets in paragraph 3.18 of the ICAEW/ICAS Technical Release 02/17BL – Guidance on Realised and Distributable Profits under the Companies Act 2006 (TECH 02/17BL). Paragraph 3.18A of TECH 02/17BL states that when the consideration received comprises a combination of assets and liabilities, the profit will be realised only to the extent of any net balance (i.e. cash less liabilities) of qualifying consideration received. In Example 8.13 above, the realised profit of £5m consists of the cash received of £25m less the bank loan assumed of £20m.

No gain or loss is recognised in those rare cases where the artificiality or lack of substance of the transaction is such that a gain or loss on the exchange could not be justified. When a gain or loss on the exchange is not taken into account because the transaction is artificial or has no substance, the circumstances should be explained. [FRS 102.9.32]. There is no elaboration as to the circumstances where this might be applicable.

3.9 Disclosures in consolidated financial statements

4.1 Accounting for associates and jointly controlled entities in individual financial statements of an entity that is not a parent

An entity that is not a parent accounts for investments in associates and jointly controlled entities using either:

• a cost model, i.e. at cost less impairment;
• a fair value model, i.e. at fair value with changes in fair value recognised in other comprehensive income (or profit or loss to the extent that it reverses revaluation movements in profit or loss or where the revaluation reserve would otherwise be negative); or
• at fair value with changes in fair value recognised in profit or loss. [FRS 102.9.25, FRS 102.14.4, FRS 102.15.9].

There is no option to use equity accounting in individual financial statements prepared under FRS 102 (although this option exists under IFRS and Schedule 1 to the Regulations). [FRS 102.BC.A28(a)]. However, the individual financial statements of an investor that is not a parent shall disclose summarised financial information about investments in associates and jointly controlled entities, along with the effect of including those investments as if they had been accounted for using the equity method. Investing entities that are exempt from preparing consolidated financial statements, or would be exempt if they had subsidiaries, are exempt from this requirement. [FRS 102.14.15A, 15.21A].

In its individual financial statements, an entity that is not a parent need not measure associates using the same accounting model as jointly controlled entities. However, Sections 14 and 15 do not explicitly address whether all associates or all jointly controlled entities must all be accounted for using the same model. There is an explicit requirement in Section 9 for an entity that is a parent to apply the same accounting policy to all investments in a single class. As discussed at 4.2 below, in our view, associates or jointly controlled entities held as part of an investment portfolio could be considered as a separate class from other associates or jointly controlled entities in the separate financial statements of a parent. While Sections 14 and 15 do not specifically refer to different classes of associates and jointly controlled entities, we believe that an entity that is not a parent may similarly adopt a different accounting policy in accounting for associates and jointly controlled entities held as part of an investment portfolio to that applied to other associates and jointly controlled entities in its individual financial statements.

The cost and fair value measurements for associates and jointly controlled entities are further discussed in Chapters 12 and 13.

4.2 Accounting for subsidiaries, associates and jointly controlled entities in separate financial statements of an entity that is a parent

Separate financial statements are defined as those financial statements presented by a parent in which the investments in subsidiaries, associates or jointly controlled entities are accounted for at either cost, or fair value rather than on the basis of the reported results and net assets of the investees. Separate financial statements are included within the meaning of individual financial statements. [FRS 102.9.24].

A parent preparing separate financial statements must select and adopt a policy of accounting for investments in subsidiaries, associates and jointly controlled entities either: [FRS 102.9.26]

• at cost less impairment;
• at fair value with changes in fair value recognised in other comprehensive income (or profit or loss) in accordance with paragraphs 15E and 15F of Section 17 – Property, Plant and Equipment; or
• at fair value with changes in fair value recognised in profit or loss. Guidance on fair value is provided in Section 2 – Concepts and Pervasive Principles (see Chapter 4 at 3.13).

A policy of measuring subsidiaries, associates and jointly controlled entities at fair value through profit or loss is permitted by paragraph 36(4) of Schedule 1 to Regulations (and its equivalents in Schedules 2 and 3) without the use of a true and fair override. However, additional disclosures are required – see 4.6.1 below.

There is no option to use equity accounting in separate financial statements prepared under FRS 102 (although this option exists under IFRS and Schedule 1 to the Regulations). [FRS 102.BC.A28(a)].

A parent that is exempt from the requirement to prepare consolidated financial statements (see 3.1.1 above) and therefore presents separate financial statements as its only financial statements must also account for its investments in subsidiaries, associates and jointly controlled entities as above. [FRS 102.9.26A].

A parent must apply the same accounting policy for all investments in a single class (for example subsidiaries that are held as part of an investment portfolio, those subsidiaries not held as part of an investment portfolio, associates or jointly controlled entities) but it can elect different policies for different classes. [FRS 102.9.26]. Although not mentioned as an example of a class of investments, it appears that associates and jointly controlled entities which are held as part of an investment portfolio (and therefore required to be measured at fair value through profit or loss) could also be a separate class from associates and jointly controlled entities which are not held as part of an investment portfolio. Otherwise, an investor with, say, an associate held as part of an investment portfolio – that wished to maintain the same accounting in the consolidated and separate financial statements – would be required to measure all associates at fair value through profit or loss.

This restriction means that a parent cannot use a different accounting policy for a class of investments even where individual investments within that class have different characteristics. The Triennial review 2017 amended paragraph 26 of Section 9 to clarify that a subsidiary excluded from consolidation which is held as part of an investment portfolio is a separate class of investment. Subsidiaries that are excluded from consolidation because they are held as part of an investment portfolio are required to be measured at fair value through profit or loss. [FRS 102.9.9C(a)]. While the term ‘class’ has not been referenced to Appendix 1: Glossary to FRS 102, generally a class is taken to mean a grouping of assets of a similar nature and use in an entity's operations. Although the examples given for separate classes of investments differentiate between subsidiaries held as part of an investment portfolio and those that are not so hold, in our view, this does not preclude the election of a different accounting policy for different classes of subsidiaries. For example, an entity may consider it appropriate to account for investments in subsidiaries held exclusively with a view to resale (including those not held as part of an investment portfolio) at fair value, while applying the cost model to other investments in subsidiaries.

If an entity has elected to measure subsidiaries at fair value but the fair value of one or more subsidiaries is not reliably measurable its carrying amount at the last date the asset was reliably measureable becomes its new cost. The entity should measure the asset at this cost less impairment, if any, until a reliable measure of fair value becomes available. [FRS 102.2A.6].

There is no option under FRS 102 to use a directors' valuation (typically, net assets), an out-of-date market value (except when a reliable measure of fair value is no longer available for an asset measured at fair value) or current cost to value an investment in a subsidiary, associate or jointly controlled entity in individual or separate financial statements where such measurements are not the equivalent of fair value at the reporting date.

FRS 102 does not distinguish between different types of entity (e.g. banking entities, insurance entities and other entities). The cost model is not permitted by Schedule 3 to the Regulations for individual or separate financial statements so an insurer is able only to use fair value measurement for investments in subsidiaries.

4.3 Group reorganisations

Group reorganisations involve the restructuring of the relationships between companies in a group by, for example, setting up a new holding company, changing the direct ownership of a subsidiary with a group or transferring businesses from one company to another. FRS 102 provides no explicit guidance on how to account for group reorganisations in separate financial statements. However, when the group reorganisation involves investments in subsidiaries, the requirements of Section 9 to account for investment in subsidiaries at either cost or fair value (see 4.2 above) will apply. When the cost model is applied, the discussion at 4.2.1 above should also be considered.

Example 8.16 below illustrates three scenarios for the accounting in the separate financial statements of a parent which measures investments in subsidiaries at cost less impairment and transfers one subsidiary to another subsidiary.

Accounting for a group reorganisation that is the acquisition of a business which is not an entity should, in individual financial statements, follow the requirements applicable to group reorganisations dealing with the application of merger accounting in individual financial statements as discussed in Chapter 17 at 5.4.

4.4 Common control transactions in individual and separate financial statements

Transactions often taken place between a parent entity and its subsidiaries or between subsidiaries within a group that may or may not be carried out at fair value. FRS 102 provides no accounting guidance on such transactions.

The CA 2006 states that where a company makes a distribution consisting of, or including, or treated as arising in consequence of the sale, transfer or other disposition of a non-cash asset such a distribution can be made at an undervalue only if the company has positive distributable reserves at the time of the distribution. [s845]. When a company makes a distribution of a non-cash asset, any part of that asset which represents an unrealised profit, can be treated as a realised profit for the purpose of determining the lawfulness of the distribution. [s846].

In addition, group reconstruction relief can be applied when a subsidiary issues shares in exchange for a non-cash asset (see 4.2.1 above).

The following sections deal with common transactions between entities under common control. See also Chapter 17 at 5.4 for accounting for group reconstructions in individual financial statements.

4.5 Intermediate payment arrangements

The requirements in respect of intermediate payment arrangements are, in substance, designed to ‘consolidate’ an employee benefit trust (EBT) or employee share option trust (ESOP) in individual or separate financial statements. It is explained in the Basis for Conclusions that these requirements (derived from previous UK GAAP) have been added to Section 9 to avoid an entity that has no entities that it controls other than an intermediate payment arrangement from having to prepare consolidated financial statements. [FRS 102.BC.B9.5].

FRS 102 does not define intermediate payment arrangements. However, Section 9 states that intermediate payment arrangements may take a variety of forms and that: [FRS 102.9.33]

• the intermediary is usually established by a sponsoring entity and constituted as a trust, although other arrangements are possible;
• the relationship between the sponsoring entity and the intermediary may take different forms. For example, when the intermediary is constituted as a trust, the sponsoring entity will not have a right to direct the intermediary's activities. However, in these and other cases the sponsoring entity may give advice to the intermediary or may be relied upon by the intermediary to provide the information it needs to carry on its activities. Sometimes, the way the intermediary has been set up gives it little discretion in the broad nature of its activities;
• the arrangements are most commonly used to pay employees, although they are sometimes used to compensate supplies of goods and services other than employee services. Sometimes, the sponsoring entity's employees and other suppliers are not the only beneficiaries of the arrangement. Other beneficiaries may include past employees and their dependants, and the intermediary may be entitled to make charitable donations;
• the precise identity of the persons or entities that will receive payments from the intermediary, and the amounts that they will receive, are not usually agreed at the outset;
• the sponsoring entity often has the right to appoint or veto the appointment of the intermediary's trustees (or its directors or the equivalent); and
• the payments made to the intermediary and the payments made by the intermediary are often cash payments but may involve other transfers of value.

Examples of intermediate payment arrangements are ESOPs and EBTs that are used to facilitate employee shareholders under remuneration schemes. Section 9 states that in a typical employee trust arrangement for share-based payments, an entity makes payments to a trust or guarantees borrowing by the trust and the trust uses its funds to accumulate assets to pay the entity's employees for services the employees have rendered to the entity.

Section 9 considers that although the trustees of an intermediary must act at all times in accordance with the interests of the beneficiaries of the intermediary, most intermediaries (particularly those established as a means of remunerating employees) are specifically designed so as to serve the purposes of the sponsoring entity, and to ensure that there will be minimal risk of any conflict arising between the duties of the trustees of the intermediary and the interest of the sponsoring entity, such that there is nothing to encumber implementation of the wishes of the sponsoring entity in practice. Where this is the case, the sponsoring entity has de facto control. [FRS 102.9.33].

An amendment made by the Triennial review 2017 clarifies that it is possible for an entity to be owned by a trust established for the benefit of employees without the entity controlling the trust. The example provided is one where the entity is a co-operative, owned by its employees, and all of the shares are held in trust for the individual employees but the shares never vest in individual employees, with dividends from the company being distributed to employees solely in accordance with the provisions of the trust deed. [FRS 102.9.33A].

4.6 Disclosures in individual and separate financial statements