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Accounting for Corporate Combinations and Associations
8th Edition Neal Arthur Digital Instant Download
Author(s): Neal Arthur, Louise Luff, Peter Keet, Matt Egan, Bryan Howieson,
Ronita Ram
ISBN(s): 9781488611520, 1488611521
Edition: 8
File Details: PDF, 21.63 MB
Language: english
 Combinations and
ARTHUR
Associations LUFF
KEET
EGAN
HOWIESON
RAM

ALWAYS LEARNING
Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combina pEHs〇N
 Associations

Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 Copyright © Pearson Australia (a division o f Pearson Australia Group Pty Ltd) 2017

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Cataloguing-in-Publication Data

Creator: Arthur, Neal., author.

Title: Accounting for corporate combinations and associations / Neal Arthur, Louise Luff, Peter Keet,
Matthew Egan, Bryan Howieson, Ronita Ram.
Edition: 8th edition.
ISBN: 9781488611520 (paperback)
ISBN: 9781488611971 (VitalSource)
Notes: Includes index.
Subjects: Holding com panies~Australia~Accounting.
Consolidation and merger o f corporations— A u stra lia A cco u n tin g .
Other Creators/G>ntributors: Luff, Louise, author, Keet, Peter, author; Egan, Matthew, author;
Howieson, Bryan, author; Ram, Ronita, author.
Dewey Number: 657.960994

Every effort has been made to trace and acknowledge copyright. However, should any infringement have occurred, the
publishers tender their apologies and invite copyright owners to contact them.

Pearson Australia Group Pty Ltd ABN 40 (X)4 245 943

ALWAYS LEARNING PEARSON

Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting foe Corporate Combinations and Associations 8e
 Associations ARTHUR
LUFF
KEET
EGAN
HOWIESON
RAM

Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 Contents
Preface vii
About the Authors x
Acknowledgements xii

CHAPTER 1 Text objectives and introduction to consolidation 1

1.1 Introduction 2
1.2 Some basic concepts and terminology 2
1.3 Why do entities form groups? 4
1.4 Overview of accounting for different investor-investee relationships 5
1.5 The importance of consolidation accounting 10
1.6 Application and scope of AASB 10 19
1.7 Control 26
1.8 Summary 35
1.9 Consolidation questions 36
1.10 References 40
1.11 Endnotes 41

CHAPTER 2 Principles o f consolidation 42

2.1 Introduction 43
2.2 The consolidation process—an overview 44
2.3 Elimination of the parent's investment in subsidiary asset 53
2.4 Introduction to goodwill or gain on bargain purchase 64
2.5 Elimination of intragroup dividends 86
2.6 Summary of the consolidation process 96
2.7 Comprehensive examples 97
2.8 Consolidation questions and exercises 104
2.9 References 116

CHAPTER 3 Fair value adjustments and tax effects 117

3.1 Introduction 118
3.2 AASB 3 Business Combinations 120
3.3 Consolidated financial statements and AASB 112 Income Taxes 124
3.4 Allocation of the cost of a business combination 140
3.5 Acquisition of a business operation 154
3.6 Further issues concerning the acquisition of a subsidiary 156
3.7 Comprehensive example—acquisition of a subsidiary 167
3.8 Accounting for reverse acquisitions 176
3.9 Consolidation questions and exercises 180
3.10 References 192

CHAPTER 4 Intragroup transactions 193

4.1 Introduction 194
4.2 Intragroup services 197

iv
Copyright €> Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 4.3 Intragroup borrowing and lending 200
4.4 Intragroup sales of inventories 206
4.5 Intragroup transfers of non-current assets 224
4.6 Comprehensive example 239
4.7 Consolidation questions and exercises 250

CHAPTER 5 Non-controlling interest 271

5.1 Introduction 272
5.2 Nature of non-controlling interest 273
5.3 Disclosure and measurement of non-controlling interest 277
5.4 Consolidation of partly owned subsidiaries 284
5.5 Negative non-controlling interest 306
5.6 Preference shares and the calculation of non-controlling interest 310
5.7 Consolidation questions and exercises 312
5.8 References 328

CHAPTER 6 Partly owned subsidiaries: indirect

non-controlling interest 329
6.1 Introduction 330
6.2 Ownership interests in a group 332
6.3 Consolidation of multiple subsidiaries 338
6.4 Applied issues 355
6.5 Consolidation questions and exercises 371
6.6 References 390

CHAPTER 7 Consolidated cash flow statements 391

7.1 Introduction 392
7.2 Identifying and reporting cash flows 395
7.3 Preparation of a statement of cash flows 402
7.4 The consolidation issue 412
7.5 Consolidation questions and exercises 421
7.6 References 439

CHAPTER 8 Accounting fo r jo in t arrangements 440

8.1 Introduction 441
8.2 Background to AASB 11 442
8.3 Nature and types of joint arrangements 444
8.4 Accounting for joint operations 450
8.5 Evaluation of the one-line and line-by-line methods 455
8.6 Accounting for a production joint operation 457
8.7 Transactions between joint operators 468
8.8 Revaluation of a joint operator’s remaining interest in a non-current asset 475
8.9 Note disclosures for joint arrangements 476
8.10 Consolidation questions and exercises 478
8.11 References 491

CONTENTS v
Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 CHAPTER 9 Accounting fo r associates and joint
ventures— the equity method 492
9.1 Introduction 493
9.2 Judging whether to apply equity accounting 496
9.3 The equity method of accounting 499
9.4 Presentation of equity accounting information 505
9.5 Other equity accounting issues 506
9.6 Impairment losses 517
9.7 The tax effect of the equity carrying amount of an investment 518
9.8 Comprehensive example of equity accounting~one associate 520
9.9 Note disclosures for associates 526
9.10 Example of equity accounting—two associates 527
9.11 Consolidation questions and exercises 537
9.12 References 556
9.13 Endnotes 556

CHAPTER 10 Translation and consolidation o f foreign

currency financial statements 557
10.1 Introduction 558
10.2 Important concepts 560
10.3 Translation methods for statements of comprehensive income and statements of
financial position 562
10.4 The history of Australian accounting standards 564
10.5 Determining the functional currency 565
10.6 Presentation currency 567
10.7 Translation into the presentation currency 568
10.8 Translation into the functional currency 569
10.9 Critical evaluation of translation requirements 576
10.10 Translation of statement of cash flows 580
10.11 Consolidation of the translated statement of comprehensive income
and translated statement of financial position 583
10.12 Consolidation of the translated statement of cash flows 589
10.13 Applying equity accounting to foreign operations 591
10.14 Applied issues in the translation of foreign currency financial statements 593
10.15 Consolidation questions and exercises 598
10.16 References 623

CHAPTER 11 Segment reporting by diversified entities 624

11.1 Introduction 62 5
11.2 Background to AASB 8 626
11.3 Reportable segments 633
11.4 Measurement of segment data items 639
11.5 Disclosure of segment information 641
11.6 Example of segment reporting disclosures 645
11.7 Consolidation questions and exercises 651
11.8 References 658
Index 660

vi Accounting fo r Corporate C om binations and ^so cia tio n s

Copyright €> Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 Preface
The aims of this book are to explain, illustrate and evaluate the methods used to account for
investments in other entities and contractual arrangements in the form of joint operations. A
major focus of the book is on the process of consolidation and related accounting issues that
are associated with the process of preparing financial statements for larger entities and groups,
including the preparation of information related to operating segments. In accounting for larger
groups, the accountant will need to have an understanding of the measurement of assets and
liabilities at fair value acquired and assumed as part of a business combination (including goodwill),
the measurement methods of non-controlling interest in subsidiaries, the treatment of transactions
between members of a group and the translation of the financial statements of foreign operations.
The issues covered in this book are thus of particular relevance in the modern business
environment where economic activity is increasingly dominated by large corporate groups. These
groups frequently form strategic alliances with other corporations, groups or government entities
that can take a range of forms, including joint arrangements. With the continuing trend towards
the globalisation of business, accounting for the effects of exchange rate changes is becoming
increasingly relevant to accounting practitioners. Also, an understanding of the impact of
exchange rate changes on income, financial position and cash flows is important for those involved
in financial analysis.
The book is also suitable for students in undergraduate and postgraduate accounting courses
and for candidates for professional accounting qualifying examinations (in particular the CPA
Australia or CA programs). An understanding of the topics covered in the book is relevant not
only to those intending to pursue a career in accounting, but also to those intending to pursue a
career in banking, investment advice and finance or wealth management to assist in evaluating
investment decisions and providing investment advice.
The book is structured as follows. The first part of the text (Chapters 1-7) explains the issues
and techniques relevant to consolidation accounting including:
參 Identification of subsidiaries that are part of the group with specific reference to the application
of the criterion of •control’.
參 Issues in accounting for business combinations including the measurement of goodwill (or
bargain purchase gain) associated with a business combination, and fair value issues in relation to
an acquirees assets and liabilities.
參 The inputs, processes and outputs of consolidation accounting.
• Intragroup transactions.
參 Measurement and disclosure of non-controlling interests.
參 Consolidation of multiple subsidiaries.
參 Preparation of the consolidated statement of cash flows.
The second part of the book (Chapters 8-11) covers related accounting issues that are commonly
faced by accountants preparing accounts for larger entities and groups including:
• Accounting for investments in associates and joint arrangements.
參 Translation of foreign currency financial statements.

Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 • Accounting for joint arrangements.
• Segment reporting by diversified groups and entities.
As in previous editions of the book, the sequence of the material and the content of the
individual chapters are designed to provide a text that provides instructors with maximum
flexibility. This will allow the book to be used without loss of continuity in courses that omit
certain topics covered in the text. For example, if an instructor chooses to omit the chapter on
consolidated cash flow statements from course materials, the subsequent chapters, such as the
translation of foreign currency financial statements, will link to the earlier material covered by
students. The current edition is now significantly updated for changes in accounting standards
that have occurred since the 7th edition was written. The text is based on the revised suite of
standards, including AASB 10, 11, 12, 127 and 128, that applied to investments in subsidiaries,
associates, joint arrangements and other investments as at 31 December 2015. Amendments
made to IFRS 10,11 and 12 and IAS 27 and 28 in 2014 are therefore also reflected in the book. As
well as these changes, the examples used in the text have been revised and updated for the impact
of the myriad other changes that are relevant to the preparation of financial statements, including
changes to AASB 101, Presentation o f Financial Statements, as well as recent amendments to
AASB 9, Financial Instruments.
Over time, the number of differences between Australian accounting standards and IFRS has
become fewer, as have the number of differences between US GAAP and IFRS. A new feature
in this 8th edition of the book is a description of the differences between the requirements of
IFRS (and Australian GAAP) and US GAAF Some of these differences referred to in the book, for
example the fair value option in accounting for associates under US GAAP, create potential issues
for class discussion and opportunities for students to reflect on alternate approaches.
The book retains some of the key features of previous editions that have made the book popular
with both students and instructors. The book includes extensive reference to relevant accounting
research to assist students to see the links between research, standards and practice. To cater for
students with different learning styles, diagrams have been incorporated in the text to illustrate
the main ideas and concepts. In addition, the detailed explanations and comprehensive examples
provided in the book cater for the increasing number of students studying in ‘blended learning’ or
'flipped classroom, contexts.
A key feature of the answers to the end-of-chapter exercises is the extensive use of Excel
spreadsheets, which enable students to check not just the numbers in the answers, but more
importantly the formulas used to calculate the numbers. This facilitates the understanding of the
structure of the worksheets. This allows the instructor to show how the changes in one variable,
such as the cost of acquisition, affect other variables such as goodwill.
The chapters in the book include examples that progress from relatively simple examples
through to explorations of complex practical issues. By introducing the main ideas and methods,
the book allows students to develop an understanding of the more complex issues and methods
that represent an extension of the methods used to account for simpler examples. This approach
also allows instructors the flexibility of omitting some of the more advanced issues dealt with in
separate sections at the end of most chapters.
We hope that this book proves a valuable resource for students and instructors and encourage
feedback from all users.

VIII Accounting fo r Corporate C om binations and ^so cia tio n s

Copyright €> Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 Educator Resources
A suite of resources is provided to assist with delivery of the text, as well as to support teaching
and learning. These resources are downloadable from the Pearson website: www.pearson.com.au.

SOLUTIONS M A N U A L
The Solutions Manual provides educators with detailed, accuracy-verified solutions to the end-of-
chapter problems in the book.

TEST BAN K
The Test Bank provides a wealth of accuracy-verified testing material. Updated for the new
edition, each chapter offers a wide variety of true/false and multiple-choice questions, arranged
by learning objective and tagged by AACSB standards.

POW ERPOINT LECTURE SLIDES

A comprehensive set of PowerPoint slides can be used by educators for class presentations or by
students for lecture preview or review. They include key figures and tables, as well as a summary
of key concepts and examples from the text.

DIGITAL IM AG E POW ERPOINT SLIDES

All the figures and tables from the text are available for lecturer use.

ix
Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 About the authors
NEAL ARTHUR
BEc (USyd), MCom (Hons) (UNSW), PhD (USyd), CA, is a senior lecturer in the University of
Sydney Business School. NeaYs current research areas are financial reporting and corporate
governance. He has contributed articles to Accounting and Finance, the Australian Accounting Review,
the Australian Journal o f Management, Charter, Corporate Governance, the International Journal o f
Accounting, Auditing and Taxation and the Journal o f Accounting Education. Neal has also been
a co-author of previous editions of Accounting for Corporate Combinations and Associations. He
has previously held visiting positions overseas, including at the University of Michigan and the
University of Texas. Prior to entering academia, Neal was employed at Deloitte.

LOUISE LUFF
BBus (UTS), M.Edu (USyd), CA, is a lecturer in the University of Sydney Business School and
has also lectured in the Master of Accounting Program at Macquarie University. Louise has had
significant financial reporting and management experience in both professional and commercial
organisations, including the role of an accounting technical manager for a large Australian financial
institution. She has written materials for the Chartered Accountants Australia and New Zealand
CA and Quality Assurance programs, domestic and foreign undergraduate programs at Charles
Sturt University and for various past programs within the School of Taxation at the University of
New South Wales.

PETER KEET
BEc, MBA is a lecturer at the School of Accounting at RMIT University. Peter specialises in
teaching courses based on accounting standards to both undergraduate and postgraduate
masters students. Prior to teaching at RMIT University, Peter taught financial accounting for
20 years at various other Victorian universities. Peter has also taught business finance and
auditing. Peter was actively involved in the financial accounting modules of the CPA program
for 13 years, from 2001 to 2013. Peter has acted as treasurer for a number of community-based
non-profit organisations.

M ATTHEW EGAN
BCom Melb., BSc(Env) (Hons), PhD Sydney, CA, is a Senior Lecturer in the Discipline of Accounting
in the University of Sydney Business School. His research interests include the emergence of
organisational strategies focused on 'sustainability* and understanding how that impacts on
management practice, accounting routines and other organisational behaviours. Matthew has
worked as a finance manager, company secretary, external auditor and internal auditor including
experience within a medium-sized publicly listed entity and over seven years* experience in two
chartered accounting firms in Australia and the Solomon Islands.

x
Copyright €> Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 BRYAN HO W IESO N
MCom. FCPA FAFAANZ is Associate Professor in the School of Accounting and Finance at the
University of Adelaide. He has held prior positions at the Adelaide Graduate School of Business
and the Universities of South Australia and Western Australia. His teaching and research interests
relate primarily to financial reporting and accounting standard setting but he also has strong
interests in accounting education, professional ethics and corporate governance. Bryan has
published extensively in academic and professional journals. Bryan has had a long association with
accounting standards setting in Australia including acting as an alternate member of Australias
Urgent Issues Group and the Consultative Group, and has assisted the Australian Accounting
Standards Boards (AASB) in research projects. He was recently appointed to the AASBs
Academic Advisory Panel. He has undertaken a number of consultancies in the private and public
sectors in the areas of financial reporting and codes of conduct. Bryan has served as a director
of several not-for-profit entities including as President (Australia) of the Accounting and Finance
Association of Australia and New Zealand and as Vice-President on the Executive Committee of
the International Association for Accounting Education and Research. Bryan was a member of
CPA Australia’s ‘Member of the Future’ committee, is a Past President of the South Australian
Division of CPA Australia, and now serves on CPA Australia’s Professional Qualifications Advisory
Committee.

RONITA RAM
BA, PGDip (Uni SPac), PhD (USyd), CA, is a lecturer in the Henley Business School at the University
of Reading. Prior to that Ronita was a lecturer in the Business School at the University of Sydney.
Ronita has over eight years’ teaching experience at the tertiary level. During this time she has
taught both undergraduate and postgraduate financial accounting units. Ronita^ current research
areas are international financial reporting and accounting for SMEs and developing countries.
Prior to entering academia, Ronita was employed at FricewaterhouseCoopers.

ABOUT THE AUTHORS xi

Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 Acknowledgements
FROM THE AU TH O R TEAM :
Neal Arthur wishes to dedicate this book to his family and thanks them for their support and
understanding during the period in which the manuscript was prepared.
We appreciate the assistance of the Portfolio Manager, Jo Hobson, Anna Carter Development
Editor, Bronwyn Smith Project Manager and Fiona Crawford Lead Editor.

FROM THE AUTHORS A N D PUBLISHER:

The authors and publisher would also like to thank the following academics for their invaluable
contribution in providing feedback and suggestions for this new edition. These include:
Dr Tracy Artiach, UQ Business School
Dr Dianne Mayorga, Senior Lecturer, UNSW

xii
Copyright €> Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 LEARNING OBJECTIVES
Text objectives and
A fter studying this chapter
you should be able to: introduction to
• Explain the concept of a group.
• Describe the different
classifications for investments in
consolidation
other entities and the accounting
methods that apply to each.
• Outline the historical development
of consolidated financial reporting and
demonstrate the importance of proper
consolidation accounting.
• Determine the entities that must prepare consolidated
financial statements.
• Describe the definition of control and the indicators of control as set out in M SB 10 Consolidated Financial
Statements.
• Apply the definition of control to examples likely to be found in practice (including in the not-for-profit sector).
• Identify the main uses and limitations of consolidated financial statements.

AASB standards referenced in this chapter

M S B Framework fo r the Preparation and Presentation o f Financial Statements
AASB 3 Business Combinations
AASB 5 Non-current Assets Held fo r Sale and Discontinued Operations
AASB 9 Financial Instrum ents
AASB 10 Consolidated Financial Statements
AASB 11 Joint Arrangements
AASB 12 Disclosure o f Interests in Other Entities
AASB 101 Presentation o f Financial Statements
AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors
AASB 119 Employee Benefits
AASB 127 Separate Financial Statements
AASB 128 Investments in Associates
AASB 139 Financial Instrum ents: Recognition and Measurement
AASB 1057 Application o f Australian Accounting Standards

Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 1.1 Introduction
This book describes and explains how to account for, and report upon, inter-entity
investment relationships. An Entity* is defined in paragraph 6 of SAC 1 Definition o f the
Reporting Entity, as <4any legal, administrative, or fiduciary arrangement, organisational
structure or other party (including a person) having the capacity to deploy scarce resources
in order to achieve objectives”. Entities can include companies, partnerships and trusts,
as well as other types of arrangements as indicated in the SAC 1 definition. Entities can
have many different types of relationships with each other. For example, they can buy and
sell goods and services from each other, borrow or lend money to each other, combine
to jointly produce a good or service, or one entity can take an ownership interest in
another by way of purchasing the latter entity’s equity (for instance, A Ltd (the ‘investor ’）

may purchase 100% of the issued shares of B Ltd (the investee*)). In this book our main
focus is the situation in which two or more entities combine in some way, usually but not
exclusively through equity ownership, to conduct operations. For ease of exposition, this
book will typically explore accounting for investor-investee relationships using corporate
entities, although the principles throughout the book can be applied to any type of entity
In the next section we provide a broad overview of some of the key concepts and basic
terminology that are relevant to understanding these inter-entity relationships. In later
sections of this chapter and throughout this book, these basic concepts will be explored
in greater detail.

1.2 Some basic concepts and terminology

The nature of the relationship between two or more entities can vary greatly. For example, if X
Ltd held only 5% of the issued shares of Y Ltd, then it would be very unlikely that X Ltd could
use its shareholding to impact upon how Y Ltd conducted its operations. On the other hand, if
X Ltd held 100% of the issued shares of Y Ltd, then it could effectively direct Y Ltd to behave in
any manner X Ltd wished. Clearly, the nature of X Ltd’s asset—its investment in Y Ltd—is very
different depending upon which of these two types of investment relationship it has. If X Ltd has
100% of the issued shares of Y Ltd, then it can effectively employ not only its own net
assets, but it can also use its voting power in Y Ltd to use the net assets of Y Ltd in X
Ltds operations. Consequently, the central accounting problem that is explored in this
book is, if two or more entities operate together, how should the economic impacts o f that
relationship be reflected in financial reporting? Another way of stating this problem is to
ask if we should prepare two sets of general purpose financial statements: one for X Ltd
and a separate set for Y Ltd, or is the economic substance of the relationship between
X Ltd and Y Ltd so close that they effectively operate as if they were only one entity
and so only one set of financial statements should be prepared based on the combined
net assets of X Ltd and Y Ltd? The short answer to this problem depends on the extent
to which the investor entity can direct the key relevant activities of the investee. In the
case where the investor can ‘control’ the investee, then for accounting purposes we treat
the two separate entities as though they were one *economic entity* and prepare one
set of financial statements for the economic entity, often called the 'group* financial
FIGURE 1.1 The X Ltd group statements. Figure 1.1 explains the nature of the economic entity.

2 Accounting fo r Corporate C om binations and Associations

Copyright €> Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 As X Ltd, Y Ltd and Z Ltd are companies, they each are recognised as separate entities under
the law. In principle, X Ltd, Y Ltd and Z Ltd could each present their own set of general purpose
financial statements. However, X Ltd owns 100% of the issued voting shares of Y Ltd and Y Ltd
owns 100% of the issued voting shares of Z Ltd. As X Ltd can use its voting power to direct Y Ltd’s
activities, it can effectively also direct Z Ltd’s activities because of Y Ltd’s power over the voting
shares of Z Ltd. Consequently, X Ltd controls the net assets of both Y Ltd and Z Ltd. As a result,
for accounting purposes, X Ltd, Y Ltd and Z Ltd are viewed as though they are one economic
entity. The economic entity is represented by the shaded boxes in Figure 1.1. We would call this
economic entity the *X Ltd group*.
Take a moment to consider more deeply the membership of the X Ltd group and the relationships
between the three companies that make up the group. If we begin from the bottom of the group,
Z Ltd is called the 'subsidiary* of Y Ltd because Y Ltd has control over Z Ltd due to its holding
of 100% of Z Ltd’s voting shares. In the Y Ltd/Z Ltd relationship, Y Ltd is the ‘parent’ of Z Ltd
(see AASB 10 Consolidated Financial Statements, Appendix A). However, if we then go further up the
group, we can see that this relationship is repeated between X Ltd and Y Ltd. As X Ltd controls
the voting shares of Y Ltd, X Ltd is the parent of Y Ltd and Y Ltd is X Ltds subsidiary. If we take the
whole group together, X Ltd is called the 'ultimate* parent and both Y Ltd and Z Ltd are subsidiaries
of X Ltd because X Ltd can effectively control both Y Ltd and Z Ltd. If we assume for the moment,
that the X Ltd group is a reporting entity, then it must prepare general purpose financial statements
for the economic entity that is the X Ltd group. As will be described in more detail throughout this
book, only one set of general purpose financial statements are prepared for the X Ltd group based
on the combined net assets of the parent and its subsidiary. The financial statements of the group
are called ‘consolidated financial statements’. In practice, X Ltd, Y Ltd and Z Ltd would likely
prepare individual financial statements for internal use by management but when preparing general
purpose financial reports for use by parties external to the X Ltd group, it would be usual to prepare
only consolidated general purpose financial reports. In other words, the example in Figure 1.1 is
treating the X Ltd group as the reporting entity responsible for preparing general purpose financial
reports rather than X Ltd, Y Ltd and Z Ltd being treated as separate reporting entities in their own
right. As an aside, if Y Ltd was also deemed to be a reporting entity, then it would prepare its own
consolidated financial statements for the Y Ltd group (consisting of Y Ltd and Z Ltds net assets).
The issue of identifying reporting entities is examined in more depth in Section 1.6.2 of this chapter.
It should also be noted that a group does not necessarily need to take the structure shown in
Figure 1.1. Many different types of structures could be groups for accounting purposes. As just one
example, X Ltd may own 100〇/〇of Y Ltd’s voting shares and directly own 100% of Z Ltd’s voting
shares as shown in Figure 1.2. The X Ltd group still consists of three entities but the structure of
their interrelationships is different. The common element in both Figure 1.1 and Figure 1.2 is that
X Ltd controls Y Ltd and Z Ltd.

XLtd

FIGURE 1.2 The X Ltd group

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 1.3 Why do entities form groups?
A group such as that depicted in Figure 1.1 may arise following takeover activity undertaken
to control a larger share of market activity and reduce costs per unit of output. Motivations
for a takeover include vertical or horizontal integration to increase the scale of operations and
market share. Alternatively, sometimes the companies in a group are formed (incorporated)
for a specific purpose, such as to undertake a new business opportunity or to operate in a
new location. It is possible for companies in a group to operate in the same industry, related
industries or unrelated industries. In addition, the companies may operate in different or similar
geographical regions.
The Australian Companies and Securities Advisory Committee (2000), Ramsay and Stapledon
(2001) and Dean and Clarke (2005) identified the following potential benefits of conducting
economic activity through a group structure, including:
• Reducing commercial risk or maximising potential returns by diversification.

• Attracting capital without forfeiting control. Management may not wish to allow outside investors
to increase their level of ownership in the parent company, but want outside investment as part
of their overall business.
• Lowering the risks of legal liability, including environmental and consumer liability. By setting up
a number of separate subsidiaries, certain assets can be isolated and protected from high-liability
risks. Effectively, this amounts to using the *corporate veil* to manage risk.

參 Providing better security for proposed loans. By transferring assets into a separate company, a
potential lender will have the opportunity to obtain a first charge over specific assets. This could
benefit the group by facilitating a lower cost of borrowing, particularly through project financing.

• Complying with regulatory requirements. Some multinational groups need to comply with the
domestic rules that require business operations to be conducted through local subsidiaries.
• Minimising taxation. Different countries have different company tax rates, which can be exploited
(within certain constraints) using transfer pricing

The survey by Van der Laan and Dean (2010) reports that the average number of controlled
entities for ASX-listed companies is approximately 12. Not surprisingly, the median is much
lower at four (the distribution is positively skewed). Large companies tend to have a large number
of subsidiaries—for the largest 10% of companies by market capitalisation the mean number of
controlled entities is 62 (median is 33).
While a group structure may provide significant benefits to its stakeholders, there are potential
abuses of such a structure. In Australia there have been a number of well-publicised cases recently,
such as the one involving James Hardie, which have raised issues about the structuring and
restructuring of corporate groups and ‘asset shuffling’ to achieve the strategic aims of management
(see Clarke and Dean, 2007). More generally, the global financial crisis (GFC) of 2008 provided
further examples of how structuring inter-entity relationships could be used to transfer risk and
avoid transparency in financial reporting. Such practices have challenged accounting standard
setters around the world to develop accounting rules that minimise the ability of financial statement
preparers to exploit structured entities for opportunistic purposes. Accounting standard setters*
responses to this behaviour are explored in more detail in Section 1.5.

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 1.4 Overview of accounting for different
investor—investee relationships
In Section 1.2 the focus was upon an inter-entity relationship in which the investor entity had
control over the investee entity. This gave rise to a parent/subsidiary relationship with the result
that for accounting purposes the two separate legal entities were treated as though they were one
economic entity. Of course, not all inter-entity relationships are based on one entity controlling
another. Relationships between investor and investee entities range across a continuum from
control to no special interaction (e.g., an investor may be holding an equity interest in an investee
only for short-term speculation). As stated in Section 1.2, as the strength of the relationship
between the investor and investee changes, the economic substance of the investor’s asset (i.e.，
its investment in the investee) changes. The investor’s accounting for that asset should also differ
as a result. In their efforts to ensure that general purpose financial statements present decision-
useful information, accounting standard setters have identified four types of investor-investee
relationships and specified the different accounting policies that must be adopted for each of these
four categories of relationship. Table 1.1 provides a high-level summary of the relevant accounting
requirements for investor-investee relationships.

TABLE 1.1 Summary o f accounting fo r investor-investee relationships

Nature of
relationship Relevant Accounting
between investor & Name given to Name given to accounting method for
investee investee entity investor entity standard(s) investors interest

No special Investee Investor AASB139 OR Fair value

relationship AASB9
Significant influence Associate Investor AASB128 Equity method—
proportional share of
associate's profits

Joint control Joint arrangement Venturer or operator AASB11/AASB128 Proportional share of

joint arrangement's
assets, liabilities &
expenses or the
equity method
Control Subsidiary Parent AASB10 Consolidation-
combination of all
entities' financial
statements

Table 1.1 shows that as the strength of the investor’s relationship with the investee grows, the
appropriate accounting method changes to reflect the greater level of interest the investor has
in the investee’s net assets. In the case where there is no special relationship, the investor shows
its interest in the investee as a mere 'one-line* asset (e.g., 'Investment in Y Ltd*) but at the other
extreme where the investor controls the investee， the investor’s one-line asset in the investee is
effectively replaced by all the individual assets and liabilities of the investee. As the investor-
investee relationship becomes more complex, so does the investor’s associated accounting
method. These complexities are explored in detail in later chapters but a brief summary is
provided in the following sections. In practice, an investor may have a range of investees, some of
which are ‘controlled’， some subject to joint control， some significantly influenced by the investor,

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 and some for which there is no special relationship. In such cases consolidated general purpose
financial statements would be prepared that include not only the combined financial statements
of the investor and its subsidiaries but also interests in joint arrangements and associates that are
accounted for using either the line-by-line method or the equity method.

1.4.1 Investments in controlled entities (subsidiaries)

Figure 1.1 depicts a group that comprises three companies, X Ltd, Y Ltd and Z Ltd. It was noted
in Section 1.2 that since X Ltd owns 100% of the issued capital of Y Ltd and Y Ltd owns 100%
of the issued capital of Z Ltd, X Ltd is able to control the economic resources owned by Y Ltd
and Z Ltd. X Ltd is also in a position to direct how those resources are used in operating activities.
Consequently, where X Ltd controls Y Ltd and Z Ltd, one set of consolidated financial statements
will be prepared for the X Ltd group.
Section 1.2 indicated that the companies in Figure 1.1 represent three separate legal entities.
A question arises as to whether the needs of users desiring information on the economic activities
of X Ltd are satisfied by a financial report based on the financial position and financial performance of
X Ltd (only) or whether financial information relating to the group is more relevant. The relevance
of group information can be demonstrated by using the example of the X Ltd group in Figure 1.1.
The assets of the parent X Ltd include a 100% interest in the net assets (assets less liabilities) of
Y Ltd and Z Ltd. The parent entity controls the resources and operations of all companies in the
group and investors in the parent entity need financial information based on the group to hold
management of the parent company responsible for the financial performance of the group.
X Ltd’s control over Y Ltd and Z Ltd implies the following for the investors in X Ltd:
• Since X Ltd owns 100% of the net assets of its two subsidiaries, it owns all of the equity of the
subsidiaries. For example, if Y Ltd were wound up, then X Ltd would be entitled to 100% of any
surplus of Y Ltd’s assets remaining after its liabilities were settled or extinguished
參 Any increase in the net assets of a controlled company, as represented by profits and other
comprehensive income, ultimately benefits its shareholders as residual claimants. For example,
if Y Ltd earned a profit of $10million the portion distributed as a cash dividend would increase
X Ltds net assets (and cash balance). This, in turn, could be distributed to X Ltds shareholders,
provided the legal test of solvency is met. The portion of the profit reinvested by Y Ltd, rather than
being distributed as dividends, would expand Y Ltds operations, increasing the value of the parent
company s investment asset and indirectly the value of the shares held by investors in X Ltd
參 The cash flows of the parent company are related to the cash distributions that it may receive
from a controlled (subsidiary) company.
It follows that relevant information for the shareholders of X Ltd includes the financial
performance, financial position and cash flows of its controlled investments, Y Ltd and Z Ltd, that
is, the economic entity as a whole. Financial statements that include financial information relating to
subsidiaries (i.e., the controlled entities) assist stakeholders in the group in making rational economic
decisions by releasing information about the underlying assets, liabilities and profits relating to
investments in subsidiaries. Such information also allows an assessment of how management has
discharged its accountability for the use of controlled economic resources. If this information were
given by attaching the separate financial statements of each subsidiary to the parent's financial
statements it would be difficult to use, particularly if the parent had numerous subsidiaries and there
were numerous transactions between entities within the group. The solution is to summarise the

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 financial information of the parent company and all its subsidiaries into one consolidated report
that includes consolidated financial statements reporting on the financial performance, financial
position, changes in equity and cash flows of the group. Consolidation accounting in Australia
is regulated by AASB 10 Consolidated Financial Statements. Although a number of (sometimes
complex) adjustments are required to avoid double-counting of the groups net assets, consolidated
financial statements are in principle created by adding together the financial statements of the
individual entities within the group. For example, the consolidated Statement of Financial Position
of the X Ltd group in Figure 1.1 would be obtained by adding the Statement of Financial Position
of X Ltd, to that of Y Ltd, and to that of Z Ltd. The consolidation process is explained in detail in
later chapters.
The importance of the consolidated financial statements can be seen by noting that the financial
press focuses on the profit reported by the group when commenting on the accounting results
reported by management. Indeed, such is the focus on group (compared to parent) income that the
financial press most commonly omits the reference to ‘group， when discussing the income number
Financial journalists focus on the group’s performance and how this compares to expectations.
Similarly, analysts forecast group rather than parent entity earnings and earnings per share.
Subsequent to the release of results for the year, the chairman of the board of directors of a
listed parent entity and the CEO of the listed parent entity will review and comment on the results
of operations for the period These are normally referred to as the ‘Chairman’s Review’ and the
‘Chief Executive Officer’s Report’. Comments on results and strategies are also at the level of the
group. In conclusion, analysts, the financial press, management and the board are all focused on
the measure of group earnings, which is the outcome of the consolidation process.

1.4.2 Investments in jointly controlled entities and operations

A company will sometimes share control of economic resources with another or other entities. For
accounting purposes, shared control becomes ‘joint control’ only when there is a contract between
the controlling parties stating that all strategic decisions relating to the jointly controlled economic
resources must have the unanimous consent of all the controlling parties. Note that joint control
is necessarily a lower level of power than the unilateral control that creates a parent-subsidiary
relationship. Joint control of economic resources is often necessary or desirable because the scale
of some projects is so large that one entity does not wish to absorb all of the business risks of
a project. Joint control may also be preferred to control because it enables two or more entities
to bring different economic resources to a project that enable the overall value of that project
to be maximised through their joint participation. For example, one entity may have acquired
an intangible such as a mining licence and another entity may have experience and expertise in
conducting mining operations. In some cases, joint control is necessary because the government
of a particular country may prefer that a foreign company operates in that country by way of a
joint arrangement with a local company. A joint arrangement with a local company can also bring
valuable knowledge and expertise about differences in legal and cultural aspects of conducting
business in that country. For example, in September 2014, Telstra and Telkom Indonesia entered
into a joint arrangement to provide Network Application and Services (NAS) to Indonesian
enterprises, multinationals and Australian companies operating in Indonesia. In a Telstra media
announcement, a Telstra executive noted: uBy partnering with Telkom Indonesia in the fast
growing NAS market we leverage local expertise, a respected brand and service capabilities. The
JV will deliver locally supported managed data network and security services, as well as cloud

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 and unified communications services" (see http://www.telstraglobal.com/newsitem/telstra-and-
telkom-indonesia-sign-joint-venture, accessed 24 August 2015).
One way of sharing economic resources is for all parties involved to transfer resources into a
jointiy controlled entity. For example, in the Telstra and Telkom Indonesia NAS joint arrangement,
a company was formed in which Telkom Indonesia owns 51% of the new company and Telstra
owns 49%. Note that the fact that the two parties own 100% of the voting shares between them is
not enough to establish joint control—there must also be a contract between the two shareholders
requiring unanimous consent to major decisions (AASB 11 Joint Arrangements, paragraph 7).
It is also possible for companies to share economic resources in a joint arrangement without
transferring the resources to a separate legal entity. For example, one company may agree to
share the production of an oil and gas site with another company that offers financial resources
and experience in successful site development. These arrangements are based on contractual
agreements that determine the rights and obligations of the participants. Once again, the contract
must establish that the parties have joint control.
AASB 11 classifies joint arrangements into two categories: (1) joint operations; and (2) joint
ventures. A joint operation is a joint arrangement in which the parties (known as joint operators)
have joint control over the rights to the assets and obligations for the liabilities of the arrangement.
A joint operator accounts for its interest in the joint operation using the line-by-line method.
The line-by-line method involves recognising the operators proportionate share in each asset,
liability and expense that relates to the contractual arrangements. Where, for example, the jointly
controlled asset is a wharf with a cost of $ lOmillion an operator with a 40% interest will recognise
a carrying amount of $4million (its share) for the wharf on its statement of financial position.
Unlike a joint operation, a joint venture is a joint arrangement in which the parties (known as
joint venturers) have control over the rights to the net assets of the arrangement. For example,
two telecom companies may decide to form a third company with which they will conduct a
joint venture. Each of the telecom companies owns 50% of the shares in the third company and
receives a return based on profits generated by the third company. As the rights of the telecom
companies extend only to the net assets of the third company, the arrangement is a joint venture.
It should be noted that although the creation of a separate entity for the joint arrangement might
normally be a signal that a joint venture has been formed, this is not always the case and the
classification of a joint arrangement as a joint operation or a joint venture depends on a detailed
examination of the specific facts in each case. Chapter 9 provides detailed coverage of accounting
for joint arrangements.

1.4.3 Investments in significantly influenced entities (associates)

An investee may be subject to significant influence as opposed to control or joint control. If
A Ltd has the power to participate in the financial and operating policy decisions of B Ltd,
but does not have either control or joint control over the financial and operating policies of
B Ltd, then A Ltd has significant influence over B Ltd and B Ltd is an ‘associate’ of A Ltd.
Significant influence normally occurs when one entity has a substantial ownership interest in
another entity. In practice, investments in associates are quite common, particularly for listed
companies. Investments in associates are accounted for using the equity method of accounting.
This involves the initial recognition of the investment at cost. The investment asset carrying
amount is later increased (or decreased) by the investor’s percentage share of the post-acquisition
profits (or losses) and other comprehensive income of the associate. Changes in the investment

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 asset carrying amount lead to associated changes in the profits and reserves of the investor. The
equity method reports income and investment asset values that provide more information on
investment performance and investment value than the cost method, which records revenues
when dividends are received (or receivable) and restates the carrying amount in the case of
impairment or disposal of the investment. However, there is controversy over whether the equity
method is a valid form of accounting. Some commentators argue that it is unclear whether the
equity method is a form of measuring the value of an investment in an associate or whether it
is a form of consolidation because the application of the equity method requires some of the
adjustments that are associated with preparing consolidated financial statements (Miller and Leo,
1997). In addition, given that the equity method involves the investor bringing onto its financial
statements net assets over which it only has significant influence, it is debatable whether the
equity method breaches the definition of an asset in the AASB Framework for the Preparation
and Presentation o f Financial Statements, which requires that an entity control economic resources
(paragraph 49(a)). Chapter 9 provides detailed coverage of the application of the equity method
of accounting for investments in associates.

1.4.4 Investments in other equity interests

An investor can also hold an equity interest in an investee without attaining control, joint control
or significant influence over that entity. This will commonly be the case when a company holds a
relatively small stake in the equity of another entity. It is a very common form of investment and
is usually undertaken with the objective of achieving a return on the investment (i.e., capital gains
and dividends) as a passive investor. Investments of this type may precede further investments
that eventually result in the investor achieving significant influence and even control. Normally,
small equity investments are classified as ‘financial assets’. At present， financial assets could
be accounted for using either AASB 139 Financial Instruments: Recognition and Measurement or
AASB 9 Financial Instruments. AASB 139 was issued in July 2004 and is currently the mandatory
standard with regard to the recognition and measurement of financial assets. However, as a result
of reforms instituted by accounting standard setters in response to the GFC, the various provisions
of AASB 139 are being incrementally replaced by those in AASB 9 and other standards. AASB 9,
first issued in 2009, has a mandatory application date for annual reporting periods beginning on or
after 1 January 2018. Entities have the option to ‘early adopt’, but if they do so they must apply all
the requirements of that standard (AASB 9 Ausl.3). Many entities have made the choice to early
adopt AASB 9 and so the broad requirements of both of those standards are described here. Note
that under AASB 139.2 and AASB 9.2.1, equity investments that are subsidiaries, associates or
joint arrangements are excluded from the scope of AASB 139 and AASB 9.1
AASB 139 has the following relevant requirements. Except for investments, the fair value
of which cannot be reliably measured and must be measured at cost (AASB 139. 46(c)), equity
investments are measured at fair value. The accounting for changes in fair value required by AASB
139 depends on the classification of financial assets into one of four possible categories. In the
case of small equity investments only the following two categories are relevant.

1 Financial asset at fair value through profit or loss (AASB 139.9).

This classification applies if the investment is either held for trading or is designated at fair value
through profit or loss on initial recognition. This class of financial assets is measured at fair value
with changes in fair value forming part of the profit or loss for the period (AASB 139.55(a)).

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 2 Available-for-sale financial assets (AASB 139.9).
This classification applies to investments that are designated as available-for-sale or are
investments that cannot be included in any other category. These assets are measured at fair
value. However, unlike assets classified as fair value through profit or loss, changes in fair value
are initially included as part of other comprehensive income for the period. The gain or loss is
transferred to profit or loss when either sold or written off (AASB 139.55(b)).
If an entity adopts AASB 9 for the recognition and measurement of its equity investments,
then paragraph 5.1.1 requires that those financial assets be initially measured at the fair value of
acquisition plus any direct acquisition costs. However, direct acquisition costs are expensed at
the time the financial assets are acquired if those financial assets meet the definition of fair value
'held for trading*. Held for trading is defined in AASB 9.A and, in essence, means that the financial
asset has been acquired principally for the purpose of selling or repurchasing in the short term.
AASB 9 classifies financial assets as being one of two categories, “measured at amortised cost” or
"measured at fair value". Paragraph 4.1.2(b) makes it clear that equity investments do not satisfy
the definition of “measured at amortised cost” and so they must be classified as “measured at fair
value". After initial recognition, any movements in the fair value of the equity investments must be
recognised in the entity's current profit or loss (AASB 9.5.7.1) unless the entity makes a choice to
take the movements through other comprehensive income. This choice cannot be changed later
and cannot be applied to equity investments that are “held for trading” （AASB 9.5.7.5).

1.5 The importance of consolidation

accounting
Section 1.4.1 described some of the reasons why aggregated financial information about the
group may be more decision-useful than simply the provision of financial information about
the individual members of the group. As a practice, the preparation and presentation of consolidated
financial statements has had a long history. Initially, consolidation accounting was unregulated
and entities made their own choices about whether they would provide consolidated financial
statements. However, over time it became recognised that some managers chose to structure
their groups in various ways so as to provide less accountability and transparency than would
be desired by investors, creditors and other financial statement users. For example, managers
have employed group structures to try to boost profits and asset values, hide underperforming
subsidiaries, transfer risk from one entity to another, and hide risks such as high leverage. These
undesirable practices have prompted a variety of regulatory reforms that have sought to minimise
managers* ability to use entity structures as a means of reducing the decision usefulness of their
group s financial statements. These reforms continue to the present day where recent high-profile
corporate collapses and the GFC revealed certain inadequacies in accounting regulations relating
to consolidation. This section details a history of the development of regulation associated with
consolidation as a means of demonstrating how managers have tried to use entity structures
inappropriately. It also highlights some of the key methods used to structure groups of related
entities. Understanding this history will provide a better understanding of why the current standard,
AASB 10, contains the requirements that it does and why it employs a definition of a group based
on the principle of ‘control’ rather some other more clear-cut definition such as， for example,
percentage of voting shares owned by the investor

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 1.5.1 The historical development of consolidation reporting regulations
The concept of 'holding company* (now described as a parent company) existed in the US prior
to 1850. In Australia, holding companies have been traced back to 1882 when Elder Smith and
Co Ltd acquired a subsidiary (Spence, 1949). Whittred (1987a) argues that changes in Australian
taxation laws provided one of the incentives for the growth in the formation of Australian groups.
In the US, the preparation of consolidated accounts as a means of financial reporting on the
activities of a group can be traced back to the beginning of the 20th century. During the period
from 1900 to 1940, consolidated accounts appear to have become increasingly popular. Similarly,
in the UK, consolidation accounting was widely adopted by the late 1940s (Bircher, 1988). Walker
(1978) attributes the UKs adoption of consolidated reporting to the inadequacies of conventional
accounting methods for accounting for inter-corporate investments, specifically in relation to asset
measurement and revenue recognition.
The development of groups and consolidated reporting in Australia largely follows the
experience of the US and the UK. Table 1.2 builds on a chronology prepared by Walker and
Mack (1998) and provides a summary of the evolution of Australian regulatory requirements
encouraging or requiring the presentation of consolidated financial statements.

TABLE 1.2 D evelopm ent o f Australian regulatory requirem ents fo r consolidated reporting
Year Reporting development
1925 Sydney and Melbourne stock exchanges require listed companies to provide statements of
financial position and profit and loss accounts of subsidiaries as supplements to reports of holding
companies
1927 Melbourne Stock Exchange (MSE) allows the choice of either separate accounts of subsidiaries or
aggregate statements of subsidiaries as supplements to the reports of holding companies
1928 Sydney Stock Exchange (SSE) also allows the use of aggregate statements (as above)
1936 The Victorian Com panies A ct requires ^roup accounts,, which could take the form of consolidated
accounts or separate accounts for subsidiaries
1941 SSE and MSE listing rules require newly listed companies to provide consolidated statements or
separate statements for subsidiaries
1961 Australian uniform Corporations Law requires holding companies to provide consolidated accounts
or separate accounts for all subsidiaries
1966 Australian Associated Stock Exchanges (AASE) require listed companies to provide notices of annual
results in consolidated form
1971 AASE require annual accounts to be in consolidated form (unless an alternative presentation has
been approved by the AASE)
1987 The Australian Accounting Research Foundation (AARF) issued ED 40 Consolidated Financial
Statements

1990 The Accounting Standards Review Board (ASRB) issued ASRB 1024 Conso"datec/ ftnanria/
Statements; ASRB 1024 did not take effect because of legal impediments in the Companies Code
at that time
1990 AAS 24 Consolidated Financial Statements issued
1990 AASB 1024 Consolidated Accounts issued (gazetted in 1991)
1991 The Q>rporations Law (as it was then called) was amended so that it did not conflict with the
requirements of AASB 1 0 2 4 particularly the definition of a subsidiary for the purpose of financial
reporting and the requirement to produce group accounts, which, prior to this amendment, did not
necessarily mean consolidated accounts. These amendments were necessary before AASB 1024
could be gazetted
1992 AASB 1024 and AAS 24 were revised and reissued, requiring a consolidated cash flow statement
instead of a consolidated funds statement

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 Continued
Year Reporting development

2002 ED 139 Business Com binations was issued; it prescribed the accounting treatment of goodwill
2004 AASB 127 Consolidated a n d Separate Financial Statements and AASB 3 Business Com binations
were issued
2005 ED 141 Proposed A m endm ents to A A S B 127 and ED 139 Proposed A m endm ents to A A S B 3 were
issued in July
2008 Revised AASB 3 and IAS 27 were issued. These revisions allowed for the use of the full goodwill
approach as an alternative to the purchased goodwill approach
2010 ED 171 Consolidated Financial Statements was issued
2011 AASB 10 Consolidated Financial Statements was issued
2013 AASB 10 amended to exempt certain 'investment entities* from consolidating their subsidiaries
2013 AASB 10 amended to include new Appendix E to provide implementation guidance for not-for-profit
entities

The issue of Accounting Standard AASB 1024 Consolidated Accounts in 1991 is pivotal to the
history of consolidation accounting in Australia. From the commencement of AASB 1024, group
accounts were legally required to be in the form of a single set of consolidated financial statements
that covered all members of the group. It was no longer possible to consolidate some members of
the group but selectively omit to consolidate others.

1.5.2 The debate over voluntary consolidated reporting in Australia

Table 1.2 indicates that in the decades prior to 1991, when AASB 1024 mandated accounting
requirements for consolidated financial statements, there had been a progressive strengthening of
the regulatory requirements and a narrowing of reporting options available to holding companies.
It is interesting to note that many Australian holding companies prepared consolidated accounts
before legal requirements to do so were introduced. The 1966 Australian Associated Stock
Exchanges listing rules were the first formal requirement for consolidated reporting. However,
as documented by Whittred (1986) and Walker and Mack (1998), the provision of consolidated
financial information by Australian listed companies was commonplace by the 1950s.
Whittred (1987b) attributes the evolution of consolidated reporting and its voluntary adoption
by Australian parent entities as, in part, a result of the emergence of an innovative debt market that
used cross-guarantees for debt obligations among the members of a corporate group. Typically,
a cross-guarantee would involve each company in the group becoming jointly and severally liable
for the debt obligations of some or all of the other companies in the group. This meant that a
debt provider could claim against the assets of other companies in the group if the borrowing
company defaulted on its loan payments. In addition, the debt obligations of the other companies
in the group became relevant to the debt provider because of the possibility of claim dilution (a
reduction in the probability of payment to a debt holder). Therefore, the effect of cross-guarantees
was to remove the advantage of limited liability of the individual companies within the group.
Consequently, the constraints in debt covenants, such as leverage ratios, were defined on a group
basis by including the assets and debt obligations of other group companies that were guarantors.
It follows that the most relevant financial information for the debt provider concerned not the
individual company to whom the loan had been made but the combined financial information
of the group (i.e., the consolidated financial statements). This assumes that all companies in the
group are parties to the cross-guarantee. In practice, the situation can be more complex as debt

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 might be guaranteed by some, but not all, members of the group, in which case consolidated data
for this sub-group becomes relevant to the lender.
In addition to the incentives to consolidate relating to lending contracts, Whittred (1987b) also
argues that the level of management ownership affected the incentives to prepare consolidated
financial statements. The profits of a parent entity are likely to be an inferior measure for
monitoring managerial performance relative to the consolidated profits. This is because the profits
of the parent company include dividends that are received from subsidiaries and may also be
affected by other transactions with group companies that are not at arm’s length. Therefore,
management can opportunistically manipulate the profits of the parent company by exercising
control over intragroup dividend transactions and the terms and conditions of other transactions
(e.g., management fees and inventory transfers). In contrast, the combined or consolidated profits
of the group are based solely on transactions with parties that are external to the group. The
effects of intragroup dividends and other intragroup transactions are removed.
Walker and Mack (1998) contest Whittreds (1987b) conclusions about the importance of debt
and management contracts to the evolution of consolidated reporting. They conclude instead that
the wider adoption of consolidated reporting in Australia was explained by statutory and other
forms of regulation.
The differences between the analyses of Whittred (1986, 1987b) and Walker and Mack (1998)
result from, at least in part, different interpretations of the early stock exchange rules. Hence, the
extent to which consolidation accounting in Australia was voluntarily adopted versus externally
imposed remains contentious.

1.5.3 Lessons from the corporate practices of the 1980s

Arguably the most important event in the history of consolidated financial reporting in Australia
was the issue of AASB 1024 in 1990. AASB 1024 grew out of a 1980s perception that a legally
backed accounting standard on consolidated reporting was essential to ensure that relevant and
reliable aggregate financial information was available to capital market participants.
The use of certain controversial business practices in the 1980s brought the matter of
consolidated reporting to a head. In particular, several high-profile Australian companies were
circumventing the spirit of the existing companies* legislation and avoiding a full consolidation
of all controlled activities. This was possible at that time because the Companies Act 1981 (and
the Companies Act 1961 before it) defined a group of companies subject to consolidation as one
comprising a holding company and one or more other companies that were its subsidiaries. Three
practices developed in the 1980s to avoid the consolidation of certain types of subsidiaries. Each
of these avoidance practices was justified by arguments relying on legal form rather than economic
substance and the three practices were described collectively as Mone of
Australia’s great accounting loopholes” （Blue, 1990, p. 81). A Ltd

The first avoidance practice was to interpose a non-corporate entity A Ltd holds 100% of the
between a holding company and a subsidiary company. For example, a i
units in the B unit trust

holding company could set up a unit trust in which it held all the units, B unit trust

with the unit trust used to hold the shares in a controlled company. This _
B unit trust holds 100%
practice relied on the Companies Act 1981 defining the group in terms of r of the shares in C Ltd

corporate entities only. Under the prevailing legislation, a tmst was not CLtd
a ‘subsidiary’ （because a trust is not a company) so it did not have to
be consolidated and any companies in which the trust held shares also FIGURE 1.3 The case of the interposed unit trust

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 escaped consolidation. Figure 1.3 illustrates the use of an interposed unit trust to break the nexus
between a holding company and a subsidiary company.
If A Ltd had held the shares in C Ltd directly, then A Ltd would have been a holding (parent)
company and C Ltd its subsidiary company, resulting in C Ltd being included in the consolidated
group. However, the interposition of the B unit trust meant that C Ltd no longer qualified as a
subsidiary company of A Ltd and did not have to be included in the group consolidation. The
interposed unit trust technique would often be applied to a controlled company that had high
gearing and/or was loss-making. This was because the consolidation of such a company could
significantly increase the debt ratios (e.g., debt-to-equity ratio) of the group. In some cases, the
extent of the impact of the controlled company on the overall group position may have been so
damaging as to put the holding company in default of its borrowing agreements with banks and
other lenders (Sullivan, 1985).
The second avoidance practice was based on the fact that the term ‘consolidation’ under the
1981 Companies Code (and in the Corporations Law briefly until July 1991) did not necessarily
mean consolidated accounts. As a consequence, it was common practice to omit subsidiaries
with operations in the finance industry from the group as long as adequate justification was given.
Their omission was justified on the dubious grounds that their operations were ftmdamentally
different from other companies in the group. The omitted finance subsidiaries were typically highly
geared and their inclusion in the consolidated accounts would have significantly worsened the
reported gearing of the group. The introduction of AASB 1024 Consolidated Financial Statements,
in June 1990, struck down this practice of excluding finance entities from consolidated financial
statements. This position continued in all successive consolidation accounting standards until
2013 when the International Accounting Standards Board (IASB) issued amendments to IFRS
10 Consolidated Financial Statements, allowing exemptions to certain investment entities from
consolidating their subsidiaries. The Australian Accounting Standards Board (AASB) was not
supportive of this change as it viewed the exception as being without conceptual basis and that the
exemption could lead to inconsistent reporting practices (AASB, 2011). However, given Australia’s
policy of adoption of IASB standards, the AASB was obliged to amend AASB 10 nonetheless.
Happily, the exemption is quite limited and most entities are not able to use it.
The third avoidance practice relied on a legalistic interpretation of the definition of ‘subsidiary’
in the Companies Act 1981. That interpretation required ownership of more than half of the ordinary
voting shares of another company for that company to be a ‘subsidiary’ as defined. In practice,
it became generally accepted that a company holding 50% or (say) 49.8% of the ordinary voting
shares in another company did not have to classify that other company as a subsidiary. Whether
one company had defacto control over another company was frequently treated as being irrelevant
to the subsidiary definition. Majority share ownership was central to consolidation practice and
corporate managers with incentives to exclude or remove a company from the consolidation
needed only to arrange a shareholding of 50% or less.
Sometimes a company would use a series of interlocking shareholdings in order to achieve its
control over other companies and, at the same time, protect them from being taken over by an
external party. None of these companies would be deemed subsidiaries because of the absence
of majority share ownership. Of particular notoriety was the Adelaide Steamship Company
(•Adsteam’)，which, in the 1980s, was one of Australia’s major conglomerate organisations. The
structure of the 1980s Adsteam group is shown in Figure 1.4. It should be noted that Adsteam’s
group structure has been simplified by the omission of a number of subsidiaries.

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 FIGURE 1.4 The Adsteam case

The interlocking shareholdings conveyed the impression that the Adsteam group had lower
gearing and higher profits than was actually the case (Hadden, 1992). When the Australian Stock
Exchange finally demanded that Adsteam prepare consolidated financial statements for 1991 and
the financial position of the Adsteam group was revealed, the company went into a dramatic
decline that was halted only by the systematic disposal of major assets. Adsteam survived~very
much reduced in size~as Adsteam Marine Ltd until 2007.

1.5.4 Overcoming consolidation loopholes

In order to remedy the loopholes in the Companies Act 1981 and generally improve the usefulness
of consolidated financial statements, the Australian accounting profession issued AAS 24
Consolidated Financial Statements in June 1990. AAS 24 made three fundamental changes to
consolidation accounting. First, it substituted ‘parent entity’ for ‘holding company’ and redefined
•subsidiary’ as an entity (not necessarily a company) controlled by another entity This meant
that controlled non-corporate entities, such as trusts and partnerships, had to be consolidated in
addition to companies controlled by a parent entity. Therefore the interposed unit trust technique
could no longer be used to avoid consolidating less performing and/or highly geared companies.
Second, AAS 24 required that all subsidiaries be consolidated. There were to be no exceptions to
this basic principle. Third, AAS 24 stated the criterion that control, rather than majority ownership,
would become the major trigger to determine whether consolidation would take place. The control
criterion established economic substance rather than legal form as determining the boundaries of
the consolidated group.
Following the introduction of the Corporations Legislation Amendments Act 1991, AASB 1024
Consolidated Accounts was gazetted on 20 September 1991 and made effective for financial years
ending on or after 31 December 1991. For the corporate sector, this gave the force of law to the
consolidation principles first issued as AAS 24, including the group concept and the control criterion.
Hazelton (1994) compared the consolidated financial statements of Australian parent
companies listed on the Australian Stock Exchange pre-AASB 1024 and post-AASB 1024. As
shown in Table 1.3, Hazelton found that AASB 1024 was accompanied by a significant increase
in the number of listed companies consolidating non-corporate entities and less-than-majority-
owned companies.
The information in Table 1.3 shows that there was only a 2% increase in the number of majority-
owned companies consolidated between 1990 and 1992. However, in the same period, there was

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 TABLE 1.3 Consolidation of non-corporate entities and less-than-majority-owned companies
1993 1992 1990 1989 I
Number of entities consolidated
Non-corporate entities 205 186 96 92
Majority-owned companies 7037 7253 7094 6894
Less-than-majority-owned companies 93 87 23 21
Number of listed companies consolidating
Non-corporate entities 37 37 17 18
Majority-owned companies 190 190 187 186
Less-than-majority-owned companies 40 41 16 14

an increase of 278% in the number of less-than-majority-owned companies consolidated and an

increase of 94% in the number of unincorporated entities consolidated. Both these increases
were largely attributable to the introduction of AASB 1024. AASB 1024 also introduced greater
uniformity to consolidation accounting practices.

1.5.5 Special purpose entities

Although AASB 1024 represented a major improvement in the regulation of accounting practices,
developments in financial engineering and innovative group structures revealed serious limitations
in AASB 1024 and other similar accounting standards around the globe. The 1990s onwards saw
an exponential growth in the use of so-called ‘special purpose entities’ （SPEs) that were created
to give effect to various new forms of financial risk management. SPEs had various names and
forms including ‘structured entities’ and ‘variable interest，entities. One major objective of the
development of SPEs was to allow groups to essentially move debt or risk ‘off-balance sheet’ by
putting in place arrangements that would give the appearance (and sometimes the substance) that
an entity was not part of the group， that is， the SPE was not ‘controlled’ by the group and so could
be ‘de-consolidated’. This would mean that the SPE’s financial statements would not appear in the
group's consolidated financial statements and, in turn, this would make it difficult for users of the
group's financial statements to fully assess any potential risks faced by the group.
The use of SPEs was not entirely new. For example, the Australian property developer Hooker
Corporation had created a special trust as an SPE in the late 1980s as a means to implement a
debt defeasance arrangement. The objective was to transfer to the trust a large amount of the
liabilities of Hooker Corporation and some financial assets such as accounts and loans receivable.
It was hoped that the cash flows generated from the receivables would be sufficient to pay off
the liabilities. The management of Hooker Corporation argued that the company had effectively
transferred responsibility for the liabilities to the SPE trust and so the liabilities could be taken off
the statement of financial position of Hooker Corporation, thus improving the company s leverage
position. Such a practice would be legitimate provided that the company no longer had any
responsibility for repaying the liabilities if the SPE trust could not meet the obligations. Ultimately,
Hooker Corporation collapsed leaving huge losses for investors and creditors.
Since that time the use of SPEs has become widespread and controversial. One of the largest
corporate collapses in history, Enron Corporation (Enron), took the use of SPEs to unprecedented
extremes as described in Exhibit 1. Enron was able to exploit the rules-based consolidation
accounting standards in the US to keep its SPEs off-balance sheet. It has been argued that Enron

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 EN RO N S USE OF /RAPTOR/ SPEs
The failure o f the US company Enron was one o f the world’s most high-profile corporate collapses.
The company entered into bankruptcy in December 2001 causing widespread losses to thousands of
employees, investors and others. Enron employed many misleading accounting practices to boost its
revenues and hide risks. One o f these practices was the use o f SPEs. From 1993-2001 Enron created EXHIBIT
over 3000 SPEs (in Australia at August 2015, the whole Australian Stock Exchange consisted o f only 2205
listed entities). It was determined that Enron*s use o f these SPEs led to an overstatement o f its net assets
by $US1.2 billion. One sub-set o f these SPEs was the so-called 'Raptor* SPEs (named after various birds
o f prey). Essentially, the Raptor SPEs were created to act as a hedge against falls in Enron's portfolio
o f e-commerce investments but the assets transferred to the SPEs to act as If the hedge were Enron's
own shares. That is, Enron was using the SPEs to hedge itself. N ot surprisingly, when the market value
o f Enron’s portfolio o f e-commerce investments ultimately fell, so did the value o f Enron’s own shares,
making the hedge ineffective. This led to losses o f $US700million. The financial position o f the Raptor
SPEs was largely unknown outside Enron because the company exploited the b rig h t line' rules used by
the relevant US consolidation accounting standard. Enron structured the ownership interests in the Raptor
SPEs in such a way that a sufficient p>ortion o f that ownership was held by a partnership controlled by
Mr Andrew Fastow, the Chief Financial Officer o f Enron! As a result, the Raptor arrangements were not
presented in Enron*s consolidated financial statements. Critics o f the US accounting standards pointed to
Enron’s ability to put ’form over substance' as an example o f the limitations o f Vules-basecT accounting
standards. It was argued that ^rinciples-based' standards that employed a test for consolidation based
on ’control’ would be superior standards because they emphasised the reporting o f the substance o f such
Structured arrangements. Source: Adapted from Baker and Hayes, 2004.

would not have been able to do this if the US had adopted a *control-based test such as that now
found in AASB 10 (Baker and Hayes, 2004).
One of the key reasons for the extensive growth in SPEs has been the practice of ‘securitisation’.
In brief, securitisation is a process in which financial assets are bundled together in saleable parcels
(i.e., they are ,securitised,), which are then sold to an SPE, which in turn sells them to investors. In
practice, securitisation arrangements can be highly complex but a simplified example is provided
in Figure 1.5.

(
D □ 广

w Various
BankX SPE Trust
^ ________ investors
w

□ 13 、
FIGURE 1.5 A simple securitisation arrangement

In Figure 1.5 Bank X transfers some financial assets such as mortgage or credit card
receivables to a trust that the bank has created as an SPE (this is shown as arrow A in Figure
1.4). Bank X treats the transfer as a *salef of the financial assets, taking them off its statement of
financial position and potentially recognising a gain or loss on the sale. The SPE then bundles
these receivables into saleable packages and, in turn, sells them to various investors (shown as
arrow B). The cash flows received from the investors are used by the SPE to pay Bank X for the
receivables (shown as arrow C). The SPE then manages the cash flows from the receivables (i.e.,
it collects the payments made by the mortgagees or credit card holders as they pay their debts)

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 and transfers these cash flows to the investors, which is their return on their investment (shown
as arrow D). It can be seen that, in principle, Bank X is able to transfer the credit risk associated
with the receivables to the investors. By 'selling* the receivables to the SPE, Bank X has no
obligations to the investors if the receivables become impaired. In addition, Bank X enjoys a cash
flow advantage in that it does not have to wait the life of the receivables to collect the associated
cash flow. The key issue with regard to consolidation accounting is that the SPE must not be
a subsidiary of Bank X, that is, Bank X must not ‘control’ the SPE otherwise it would have to
consolidate the SPE's financial statements with its own and the financial reporting advantages of
creating the SPE would be lost. In practice, a variety of arrangements are put in place to try to
ensure that the SPE is not perceived to be ‘controlled’ by the bank. In any specific securitisation
arrangement, it is a question of fact as to whether the terms and conditions result in an effective
separation between the bank and the SPE or whether the SPE in substance remains controlled by
the bank. For instance, if the investors could obtain recourse from the bank in the event that the
receivables became impaired, then this would indicate that the bank has not been able to transfer
the risks to the SPE and that a tme 'sale* had not occurred. Securitisation arrangements and their
associated SPEs were a major component of the lack of transparency regarding financial risk
during the GFC and this was a key motivation for accounting standard setters around the world
to revise consolidation accounting standards. These revisions led to our current standard, AASB
10. It is worth noting that the use of SPEs is not restricted to financial institutions. In 2013, for
example, it was reported that the Australian supermarket chain Coles was able to use an SPE
to acquire a highly desirable piece of real estate without alerting its rival Woolworths. It was
reported that “Coles concealed its involvement in the deal by using a $10 company ultimately
owned in the British Virgin Islands tax haven to purchase the 4282 square metre site in the well-
heeled lower north shore suburb" in Sydney (Ferguson and Vedelago, 2013).

1.5.6 Changes introduced by AASB 127 and AASB 3

AASB 1024 regulated the preparation of ‘consolidated accounts’一 the financial statements of the
consolidated group. AASB 127 Consolidated and Separate Financial Statements extended the scope
of AASB 1024 by including both group financial statements and the 'separate* financial statements
of the parent entity. In addition, AASB 127 introduced other subtle but significant differences—in
both the application provisions and in the steps taken to determine the existence of ‘control’ 一
from similar provisions in AASB 1024. While in AASB 127 basic consolidation procedures did not
change from those in AASB 1024, there were changes in more advanced consolidation issues.
AASB 1024 relied on AASB 1013 Accounting for Goodwill and AASB 1015 Acquisition o f Assets
for (i) the measurement of the cost of acquisition, (ii) the measurement of net identifiable assets
acquired, and (iii) the measurement of and the accounting treatment for goodwill or discount (later
labelled 'excess') on acquisition.
From 2005, the role of AASB 1013 and AASB 1015 was superseded by AASB 3 Business
Combinations. AASB 3 introduced marked changes to former consolidation procedures and
resulted in the recognition of more identifiable intangibles (such as patents and trademarks) that
are acquired as part of a business combination. Chapters 2 and 3 examine issues relating to the
recognition and measurement of assets acquired as part of a business combination.
AASB 127 took the view that consolidated financial statements were prepared to enable
reporting on the activities of a group to external users. In line with this emphasis, consolidated

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 financial statements include the consolidated assets and liabilities of all members of the group, and
group equity shows the respective shares attributable to the two categories of owners一 the parent
interest and the non-controlling interest. This is known as the ‘entity concept’ to consolidation
accounting. AASB 10 continues AASB 127's approach of adopting the entity concept.
It was noted in Section 1.5.5 that the GFC exposed limitations to consolidation accounting
standards such as AASB 127. Consequently, the IASB revised its consolidation standard and
Australia followed suit in 2011 with AASB 10 Consolidated Financial Statements. These changes
resulted in the guidance on consolidation being removed from AASB 127 and that standard
was renamed Separate Financial Statements. The objective of the revised AASB 127 is to set
out the requirements for accounting and disclosure of a parent or an investor entity’s interests
in a joint arrangement or associate where that parent or investor entity prepares its own
financial statements rather than consolidated financial statements. These requirements are
explored further in Section 1.6.3. AASB 10 now contains the relevant accounting requirements
for consolidation. The basic consolidation procedures are largely unchanged from those that
were originally in AASB 127 but AASB 10 introduced a revised definition of ‘control’ and
provided extensive guidance on the practical implementation of that definition. Unlike its IASB
counterpart, AASB 10 was also amended in 2013 to add implementation guidance for entities
in the not-for-profit sector as described in Section 1.7.7. Disclosure requirements relating to
investments in subsidiaries, joint arrangements and associates are set out in AASB 12 Disclosure
o f Interests in Other Entities. The requirements of AASB 12 will be explained where relevant in
other chapters of this book.
Before considering the underlying concepts and techniques of consolidation accounting
it is necessary to understand the scope of AASB 10; that is, which companies must prepare
consolidated financial statements and the meaning of the term ‘separate financial statements’.
This is considered below in Section 1.6.

1.6 Application and scope of AASB 10

The application of AASB 10 is governed by paragraph 5 of AASB 1057 Application o f
Australian Accounting Standards. In relation to such compliance it is worthwhile remembering
that the application of AASB standards not only applies to companies but also to entities
other than companies, including not-for-profit organisations and public sector entities. AASB
10.E provides direct guidance on the application of the concept of control in the not-for-
profit sector. Although the emphasis in this text is on the application of AASB standards to
companies, the application of the control concept in the not-for-profit sector is briefly revised
in Section 1.7.2.
AASB 10 refers to consolidated financial statements and AASB 127 refers to separate financial
statements. Previous sections of this chapter outlined the nature of consolidated financial
statements, but there has been no discussion of ‘separate’ financial statements; this concept will
be explained in Section 1.6.3.

1.6.1 The requirement to prepare consolidated financial statements

Australian accounting regulations embrace the concept of differential reporting as described in
SAC 1 Definition o f the Reporting Entity, paragraphs 34-37.2The idea behind differential reporting is

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 that it is unreasonable to expect the same level of accounting disclosure in the financial statements
of a private family company as would be required in the report of a publicly listed company. The
implementation of differential reporting depends on the interaction between the requirements
of the Corporations Act 2001 (hereafter referred to as the Corporations Act or 'the Act') and the
application provisions in AASB accounting standards.

CO RPO RATIO N S A C T
Provisions of the Corporations Act include:

• Part 2M.3, s. 292 specifies the entities that must prepare annual financial reports. In general,
small proprietary companies are exempted from the requirement to lodge financial reports.
Section 292 applies to various types of individual companies.
參 Section 295 outlines the content of the annual financial report prepared by the companies
specified in s. 292. The required content of a financial report includes the financial statements
required by AASB accounting standards or, where required by accounting standards, financial
statements of the consolidated entity (s. 295(2)(b)). The ‘financial report’ is defined to include
notes to the financial statements (consisting of notes required by accounting standards, the
regulations and other information necessary to give a true and fair view) and the directors*
declaration about the financial statements and notes. Detailed requirements about format and
content of financial statements and notes thereto are prescribed by AASB standards rather
than by the Act.

參 Since revisions to the Act in 2010, annual financial statements are required to be prepared
for a company unless accounting standards require consolidated financial statements. In this
case only consolidated financial statements are required to be provided to shareholders of the
parent company.

• Section 296 requires that financial statements comply with accounting standards and s. 297
requires that financial statements and notes must give a true and fair view, but does not allow
any departure from the requirements of accounting standards. This means that any additional
information necessary for a true and fair view is included in notes to financial statements
(s.29W3)(c)).

AASB A C C O U N T IN G STANDARDS
Provisions of the AASB accounting standards include the following:
• The Corporations Act requires that financial statements comply with accounting standards.
The application of an accounting standard to a particular class of entity is stated in
AASB 1057.5.
• Generally, AASB standards apply only to 'reporting entities' (as defined in Table 1.4). The
application provisions in AASB standards implement differential reporting in accordance with
the AASBs Reduced Disclosure Requirements (RDR).
• Reporting entities are defined in terms of the financial information needs of external users so that
closely held, equity-financed, unlisted public companies and/or large private family companies
are not normally reporting entities.
• Only reporting entities are exposed to the full weight of accounting disclosure.

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 1.4 Relevant definitions3
Definition Reference 1

Parent An entity that controls one or more entities AASB10A

Entity Any legal, administrative or fiduciary arrangement, organisational stmcture SAC 1.6
or other party (including a person) having tfie capacity to deploy scarce
resources in order to achieve objectives
Subsidiary An entity that is controlled by another entity AASB10A
Group A parent and its subsidiaries AASB10A
Reporting entity An entity (including an economic entity) in respect of which it is reasonable SAC 1.40
to expect the existence of users dependent on general purpose financial
reports for information which will be useful to them for making and
evaluating decisions about the allocation of scarce resources. A reporting
entity prepares general purpose financial statements
General purpose Financial statements that are intended to meet the needs of users who are AASB 101.7
financial statements not in a position to require an entity to prepare reports tailored to their
particular information needs

The financial statements required by s. 295 are prescribed in AASB 101.10. The following
financial statements must be included as part of the content of a set of financial statements:
參 A statement of financial position.
參 A statement of profit or loss and other comprehensive income.
• A statement of changes in equity.
參 A cash flow statement.
• Notes.
An additional statement of financial position is required in certain cases where there has been
a retrospective accounting policy change, a restatement or reclassification (AASB 101.10(f)).
The standard with the power to require the preparation of consolidated financial statements
(pursuant to s. 295) is AASB 10. Since AASB 10 must be read in conjunction with other AASB standards,
consolidated financial statements are therefore required under AASB 101.10. Only companies caught
by the application provisions of AASB 10 need to prepare consolidated financial statements.
In determining the application of AASB 10, an understanding of the terms ‘parent entity’,
•group，，‘subsidiary’， ‘reporting entity’ and the related terms •entity’ and ‘general purpose financial
statements’ is necessary. Most of these terms were introduced in Section 1.2 but formal definitions
are given in Table 1.4.
While it is clear that AASB 10 applies to entities other than companies, the discussion here
concerning the application of AASB 10 is restricted to companies since parent entities in this
text will be companies. More generally, the application of AASB 10 is governed by AASB 1057
Application o f Australian Accounting Standards. AASB 1057.5 requires AASB 10 to be applied to:
a. each entity that is required to prepare financial reports in accordance with Part
2M.3 of the Corporations Act and that is a reporting entity;
b. general purpose financial statements of each other reporting entity; and
c. financial statements that are, or are held out to be, general purpose financial statements.
The general requirement to prepare consolidated financial statements arises where the entity
is a parent (AASB 10.4). A limited exemption is provided by AASB 10.4(a). This is the special case

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 where the parent is itself a subsidiary (i.e., part of a larger group), its securities are not publicly
traded, the entity is not in the process of filing statements for the purpose of issuing instruments
in a public market and its parent produces consolidated financial statements that comply with
International Financial Reporting Standards (IFRS). This would generally exempt, for example, an
unlisted parent company that was a subsidiary of a parent listed on the London Stock Exchange
(but generally not if the parent was listed on the New York Stock Exchange). There are two other
exemptions that relate to long-term employee benefit plans that are subject to AASB 119 Employee
Benefits (AASB 10.4A) and investment entities if they measure all of their subsidiaries at fair value
through profit or loss (AASB 10.4B).
There is significant international variation in the requirement to prepare consolidated financial
statements. In Australia, the requirement to present consolidated financial statements is stated in
AASB 10.Aus4.2:
Notwithstanding paragraphs 4(a) and Aus4.1, the ultimate Australian parent shall
present consolidated financial statements that consolidate its investments in
subsidiaries in accordance with this Standard when either the parent or the group
is a reporting entity or both the parent and the group are reporting entities.
The interaction of paragraph Aus4.2 in AASB 10 requires that either the parent company
or the group be reporting entities for the standard to apply. In the rare case where the parent
is a non-reporting entity but the group is a reporting entity, AASB 10 does not apply to
either the parent or the group in the strict legal sense. In this case, the parent company is
not obliged to present either separate general purpose financial reports (GPFRs) for itself
or consolidated financial statements for the group, though there is no barrier to the parent
voluntarily submitting GFFRs for the parent and for the group in the form of consolidated
financial statements. It is never incorrect to disclose more than the minimum information
required by accounting regulations.
If the parent entity is a reporting entity, it would be unusual for the group to be classified as a non­
reporting entity. It could occur if all subsidiaries were wholly owned and the parent^ investments
in subsidiaries were relatively unimportant to other activities of the parent—that is another way of
saying the information in consolidated financial statements is not material (see AASB 108.5).
In practice, the usual situation would be for both the parent and the group to be either reporting
or non-reporting entities. Where both the parent and the group are non-reporting entities, the
parent will prepare either special purpose financial reports or GFFRs and can also present special
purpose or general purpose consolidated financial statements if it chooses to do so. In all practical
illustrations and end-of-chapter exercises in this text, both parent and group will be reporting
entities required to prepare GPFRs. We will also assume that the effect of consolidation is material
and that consolidation adjustments are material.

1.6.2 A group that is a reporting entity

A group is classified as a reporting entity when it meets the definition of ‘reporting entity’ given
in Table 1.4. In determining whether a group is a reporting entity, it is necessary to ask: Are there
users who require regular financial reports about the entity?
If the answer to the above question is yes, then ask: Are some of these users unable to command
the financial information they require for decision-making and accountability purposes?
If the answer is yes to this second question as well, then the group is a reporting entity.

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 To assist in deciding whether a group is a reporting entity, SAC 1 Definition o f the Reporting
Entity provides the following factors, which should be considered in determining whether the entity
is a reporting entity.
參 Separation of management from economic ownership interest—tightly held and controlled
entities (e.g., private family companies) are normally not reporting entities. Widely held companies
will normally be reporting entities as shareholders of such companies are normally not in a
position to demand financial information specific to their own needs and therefore must rely on
GPFRs (SAC 1.20).
參 Economic or political importance/influence~economically large and politically significant
entities have a ‘public accountability’ function that may make them reporting entities
(SAC 1.21).
參 Financial characteristics—entities that are large by reference to value of assets or sales,
number of employees or level of indebtedness can also be deemed to be reporting entities.
In such cases there may be non-shareholder financial interests that need to be served by
GFFRs (SAC 1.22).
The inclusive nature of the definition of a group should also be considered when determining
if a group is a reporting entity. For example, if the parent entity is listed on a stock exchange,
offers debt securities to the public or is a corporate subsidiary of a foreign-listed company, then
the parent is a reporting entity and, as discussed previously, the group, by implication, is normally
also a reporting entity.
It is important to remember that the factors noted in SAC 1 are provided for guidance only and
should not be seen as a substitute for applying the definition to all the available facts concerning
each potential reporting entity.
As described in Section 1.2, a group that is a reporting entity can take a number of different
forms. Figure 1.6 depicts the simple case of a group with one subsidiary.
The A Ltd group comprises the parent entity, A Ltd, and its subsidiary, B Ltd. If A Ltd or the
A Ltd group are reporting entities, then A Ltd must include consolidated financial statements
prepared in accordance with AASB 10 as part of its annual financial reports.
Sometimes it is possible to identify more than one parent entity and more than one group.
Figure 1.7 depicts a chain of companies similar to that in Figure 1.1 where this is the case.
As discussed in Section 1.2, a company like B Ltd is the parent entity of C Ltd and the B Ltd
group comprises B Ltd and its subsidiary, C Ltd. However, A Ltd controls B Ltd and, through it,
also C Ltd. Therefore, A Ltd is the parent entity of both B Ltd and C Ltd and the A
The group
Ltd group comprises A Ltd and its subsidiaries, B Ltd and C Ltd. Where there is a
chain of companies or entities, the parent entity at the top of the chain (A Ltd in this
case) is often referred to as the ‘ultimate parent entity’. Unlike the example in Section
1.2 we now extend our analysis by asking whether both the A Ltd group and the B Ltd
group are reporting entities. The answer to this question will depend on the facts. If A
Ltd and B Ltd are both listed on the Australian Securities Exchange, both companies
will be reporting entities and both the A Ltd group and the B Ltd group would usually
be reporting entities. The position would be different, for example, if A Ltd was a
listed company and B Ltd was a non-listed, wholly (100%) owned subsidiary of A
Ltd. In this case, B Ltd and the B Ltd group are less likely to be reporting entities FIGURE 1.6 Parent entity in a
because B Ltd is not a listed company and A Ltd, as its only shareholder, will be able group with one subsidiary

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 to command specific financial information. Of course the needs
of users other than shareholders must also be considered. In this
situation, A Ltd would have to prepare consolidated financial
statements for the A Ltd group but B Ltd would not have to
report on the B Ltd group.

BLtd
economic 1.6.3 Accounting for investments in separate
entity
financial statements
Accounting for investments in subsidiaries, jointly controlled
entities and associates in separate financial statements are
addressed in AASB 127.9-127.14, which refers to the case
FIGURE 1.7 A chain of controlled companies
where the parent prepares financial statements for the parent in
addition to, or instead of, consolidated financial statements. Under
Australian legislation and accounting standards, in most cases a parent will prepare consolidated
financial statements alone. In this case, footnote disclosure is provided about the parent entity’s
financial position (e.g., total assets), performance (e.g., profit) and the methods outlined below for
accounting for investments in the separate financial statements of the investor, which affect these
measures. These methods were described in Section 1.4.
‘Separate financial statements’， as defined in AASB 127.4, are financial statements of a
parent, an investor in an associate or an investor in a jointly controlled arrangement in which the
investments are accounted for on the basis of the direct equity interest. The separate financial
statements (if prepared) show the financial performance, financial position and cash flows of the
parent entity as a single entity. On the parent’s statement of financial position, equity investments
in other entities are treated as investment assets and must not be measured on a consolidated or
equity accounted basis.
‘Separate financial statements’ is a term that relates only to the parent entity—as opposed to
‘consolidated financial statements’ that are based on the combined activities of every entity in
the group.
In the separate financial statements of a parent entity, investments in subsidiaries, jointly
controlled entities and associates are accounted for in one of two ways:

1 Investments not classified as held for sale are accounted for:

—at cost (the •cost method ’
）

一 in accordance with AASB 9 Financial Instruments, or

2 Investments classified as ‘held for sale’ are accounted for in accordance with AASB 5.

The fair value method provides information that is relevant to investors about the value of
investments. The IASB has recently decided to allow the option to use the equity method for
an associate entity in separate financial statements. The use of the fair value method provides
information that might be relevant to the parent shareholders about the value of investments. The
fact that its use was not mandated is noteworthy as it emphasises the importance of consolidated
accounts (relative to parent entity accounts) to gain information about financial position and
management performance. The IASB acknowledged that the cost method might provide relevant
information where the accounts of the parent provide information about the ability of the parent
to pay dividends to its shareholders. In many jurisdictions the directors of the parent may be

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 constrained to paying dividends out of realised earnings, which are a function of, for example,
dividends received (as opposed to capital gains). Note, however, that the case for the cost method
in providing relevant information is now weaker in Australia, as amendments to the Corporations
Act 2001 in the Corporations Amendment Act 2010 removed the *profit test* for the payment of
dividends and retained just the ‘solvency’ test.
Investments initially accounted for at cost may later be classified as ‘held for sale’. In this case
the investments are then measured at the lower of their carrying amounts and fair values less costs
to sell (AASB 5.15).
As discussed in Section 1.4.4, AASB 9 requires that financial assets be recorded at fair value.
One important exception is the case of equity instruments if there is insufficient evidence to
reliably measure the fair value (refer to AASB 9B.5.4.14). This is an important exception in the
context of corporate groups as, in most cases, the listed entity (if any) is the parent and the
subsidiaries are all unlisted.
As indicated in Section 1.4.4 and excluding investments where fair value cannot be reliably
一

measured~~AASB 9 requires changes in fair value to be reflected either in profit or loss, or in certain
circumstances the entity can choose to have these changes taken directly to other comprehensive
income. In the latter case, gains and losses cannot be subsequently transferred to profit or loss on
realisation (generally on disposal of all or part of the investment) (AASB 9B.5.7.1).
In the consolidated financial statements， the amount recorded in the parent’s separate statement
of financial position will be treated as shown below.

INVESTMENTS IN SUBSIDIARIES
In the case of investments in subsidiaries, the parent’s recorded investment will be eliminated
in full (irrespective of its measurement basis) and the underlying assets, liabilities and
post-acquisition equities of subsidiaries will be included in the consolidated statement of
financial position in place of the original investment asset. Subsequent chapters will illustrate
this procedure.

INVESTMENTS IN JO INTLY CO NTRO LLED ENTITIES A N D

ASSOCIATES
Investments classified as 'held for sale* will continue to be measured at the amount required by
AASB 5 Non-current Assets Held for Sale and Discontinued Operations. Consequently there will be
no difference between the carrying amount in the parent’s separate financial statements and the
group's consolidated financial statements.
The equity method of accounting, described in Section 1.4.3, must be applied to investments
in associates other than those held for sale. The equity method, including the consequences of
adopting the fair value basis in the parent’s separate financial statements, is the basis of the
content of Chapter 8. Discussion of the accounting treatment of investments in associates
and jointly controlled entities held by a company that is not a parent entity is also covered in
Chapter 8.
Having specified the entities that must prepare separate financial statements and/or
consolidated financial statements and that the concept of control is used to identify parents and
subsidiaries, now let’s look at the definition of ‘control’ and discuss how the existence of control
is determined.

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 1.7 Control
AASB 10.5 establishes that the criterion for determining a parent-subsidiary relationship—and
therefore the basis for preparing consolidated financial statements一 is control. The use of the
control criteria follows from the application of the ‘entity’ perspective to consolidation. Using this
approach, the group is viewed as an economic entity and accounts are prepared for this entity as
if it was a single entity. That is, we look beyond the legal form and account for the group based
on the economic substance. Using the entity approach, accounting first determines the entities
(and indirectly the resources) that are controlled by the ultimate parent. One alternative approach,
termed the ‘parent entity’ approach to consolidation， accounts for the group from the perspective
of parent company entity shareholders. This difference becomes important where one or more
subsidiaries are partly owned. As a result, shareholders with an interest in the group include
both parent company shareholders and also shareholders with a non-controlling interest in a
subsidiary. Accounting for groups where one or more subsidiaries is partly owned is addressed in
Chapters 5 and 6.
AASB 10 defines control and provides significant application guidance on how the concept of
control is to be implemented. However, because AASB 10 is a principles-based standard and must
be interpreted on the basis of professional judgement, it is possible that different sets of decision­
makers may reach opposing conclusions about the existence of control for a given set of facts.
The implementation guidance for applying ‘control’ in the context of for-profit entities is set out
in AASB 10C while AASB 10E contains implementation guidance in the context of not-for-profit
entities. It is strongly recommended that you obtain a copy of AASB 10 and very carefully study
the implementation guidance contained in these two appendices.

1.7.1 Identifying an acquirer— acquisitions and control

For the purposes of consolidation, we are interested in control that one entity has over another.
Such control arises from a business acquisition (or ‘business combination’） and requires the
identification of which entity in the acquisition is the acquirer (the entity making the purchase)
and which is the acquiree (the entity being purchased). The issue of identifying the acquirer in a
business combination is regulated by AASB 3. AASB 3 applies to business combinations generally
and is not restricted to those business combinations in which a parent entity acquires a subsidiary.
AASB 3 uses the term 'acquirer*, which is wider than the term *parent,, to describe the controlling
entity in a business combination. An acquirer is defined as ‘the entity that obtains control of the
acquiree* (AASB 3A). Note that control is the basis used to identify the acquirer in all business
combinations, including business combinations that result in the formation or expansion of a group.
A ‘business combination’ refers to a transaction or event in which the acquirer obtains control
of one or more businesses. The term ‘business’ means (AASB 3A):
. . . an integrated set of activities and assets that is capable of being conducted
and managed for the purpose of providing a return in the form of dividends,
lower costs or other economic benefits directly to investors or other owners,
members or participants.
A business generally consists of inputs, processes applied to those inputs and resulting outputs
that are, or will be, used to generate revenues. If goodwill is present in a transferred set of activities
and assets, the transferred set shall be presumed to be a business (refer to AASB 3B. 12).

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 Although a detailed discussion of AASB 3 is deferred to later chapters, it is worth noting here
that the formation of a particular type of business combination, a reverse acquisition, represents a
special application of the control concept that can yield rather unexpected consequences. A reverse
acquisition can arise from a transaction that is primarily an exchange of equity interests as, for
example, when A Ltd purchases the shares of B Ltd from the shareholders of B Ltd and issues shares
in A Ltd as the purchase consideration. An appreciation of the role of the acquirer is necessary to
an understanding of the accounting requirements of AASB 3 with respect to reverse acquisitions.
AASB 3 requires the use of the ‘acquisition method’ in accounting for business combinations.
The acquisition method looks at a business combination from the point of view of the acquirer
and hence requires that one of the parties to a business combination be identified as the acquirer.
Identifying the acquirer is a crucial step in implementing the acquisition method, but determining
the acquirer in a business combination is not always a straightforward process. Although the
definition of control and the method of determining control are almost identical in AASB 10 and
AASB 3, the latter standard suggests additional factors that may assist in identifying the acquirer
in difficult cases. Those additional factors are given as in AASB 3B.14-B.18:

參 Asset and liability transfers

In a business combination that involves the transfer of cash or other assets or the incurring of
liabilities, the entity that transfers the cash or other assets or incurs the liabilities is usually the
acquirer (AASB 3B. 14).

參 Relative size
The acquirer is usually the entity that is relatively larger than the acquiree. Financial measures,
such as total assets or revenues, could be used as proxies for entity size (AASB 3B.16).
In business combinations involving the transfer of equity interests, the following factors are
used to assist in identifying the acquirer (AASB 3B.15):

參 The relative voting rights of the combined entity after the business combination. The acquirer is
usually the entity whose owners obtain the largest portion of the voting rights in the combined
entity.

• The existence of a large minority voting interest in the combined entity. If no other owner (or
organised group of owners) has a significant voting interest, the acquirer is usually the entity
whose owner (or organised group of owners) has the largest minority voting interest in the
combined entity.

參 The composition of the board of directors (or other governing body) of the combined entity
The acquirer is usually the entity that has the ability to elect a majority of the board of directors.

• The senior management of the combined entity. The acquirer is usually the entity whose former
management dominates the management of the combined entity.
• The terms of exchange of the equity instruments. In a business combination, the acquirer
normally pays a premium for control. This premium might be evident from a comparison of the
consideration paid by one entity with the fair value of the pre-combination equity interests of the
other entity (or entities).

A detailed discussion and practical illustration of the requirements of AASB 3 will form part
of Chapter 3.

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 1.7.2 The definition of control
AASB 10A.6 defines control as follows:
An investor controls an investee 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.
Paragraph 7 indicates that there are three essential components to this definition of control,
namely: (1) the investor has power over the investee; (2) the investor has exposure or rights to
variable returns from its involvement in the investee; and (3) the investor must be able to use the
power it has over the investee to affect the amount of the investors returns. It is most important
to understand that in any given investor-investee relationship all three of these components must
be satisfied before ‘control’ can be confirmed and a parent-subsidiary relationship established. As
the AASB 10 definition of control is focused on the economic substance of the investor-investee
relationship, simple 'bright line* tests such as having more than 50% of the voting shares of the
investee are not sufficient to determine the existence of control. During the GFC, for example,
some investors had no ownership interests in another entity but were still able to get that entity to
operate in the investor entity's interests by way, for instance, of using contractual arrangements
that, in substance, transferred control over the investee to the investor. As described in Section
1.5.5, such investor entities used those contractual arrangements to ensure that they did not have
to consolidate certain investees into the group. The three components of the control definition in
AASB 10 are designed to combat such practices. Each of the three components is now examined
in more detail.

1.7.3 Power over the investee

Paragraph 10 of AASB 10 indicates that an investor has power over the investee when the investor
has existing rights that give it the current ability to direct the relevant activities of the investee.
Relevant activities are defined in AASB 10A as “activities of the investee that significantly affect the
investee’s returns”. Relevant activities are those activities that generate value from the investee. An
investor must be able to direct the relevant activities of the investee to satisfy the ‘power’ criterion
of the control definition. AASB 10B.5-B.13 provide guidance on how to identify an investee's
relevant activities. Paragraph B5 notes that to identify the relevant activities, it will be necessary to
consider the purpose and design of the investee. Although the identification of relevant activities
will always depend on the particular facts of the situation, paragraph B11 provides some common
examples of relevant activities including the buying and selling of goods or services, managing the
investee’s financial and non-financial assets or developing new intellectual property. For example,
J Ltd may be a footwear retailer, in which case its relevant activities would include the purchasing
of inventories, the selling of those inventories to customers and the financing arrangements
associated with supporting those retail activities.
The investor must have rights that give it the current ability to direct the investee's relevant
activities. Note that the investor does not have to be exercising those rights to have power over
the investee. The investor can be 'passive* but still have power. For example, A Ltd may own 80%
of C Ltd and B Ltd may own the remaining 20% of C Ltd. As at 30 June 2016 B Ltd may be
actively involved on a day-to-day basis in the management of C Ltds operations. However, in the
absence of any other information, B Ltd does not control C Ltd for the purposes of AASB 10.

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 Although A Ltd has not exercised the power that comes from its 80% holding of C Ltds voting
shares, it has the current capacity to do so if it wished. It could out vote B Ltd and veto any of B
Ltd’s decisions with regard to the relevant activities of C Ltd Consequently, based on these limited
facts, A Ltd would control C Ltd In this example, A Ltds rights are determined by its superior
voting power that come from it holding the issued share capital of C Ltd. AASB 10B.22 identifies
these types of rights as being ‘substantive rights’ ；that is， a substantive right is one that the investor
has the practical ability to exercise. For instance, if the facts in the example above were changed
such that A Ltd only held options that would give it 80% of the voting shares of C Ltd and those
options were currently 'out of the money* (i.e., it would not be economically viable to exercise
the options), then A Ltd would not have substantive rights over the relevant activities of C Ltd
and would not have power over C Ltd. If, however, those options were currently exercisable, then,
depending on any other facts, A Ltd could be seen to have the capacity to control C Ltd even if it
has not yet exercised that capacity.
Substantive rights are not limited to those that arise from holding equity in the investee.
Substantive rights could arise from a legal contract or from legislation or other regulations, for
example. As the name implies, substantive rights are identified on the basis of the Substance*
of the investor-investee relationship rather than its apparent form. For example, it was noted in
Section 1.5.3 that traditional tests of parent-subsidiary relationships were based on the percentage
of voting equity held by the investor in the investee. Typically an investor entity having a share
ownership of more than 50% in the investee was viewed as giving rise to control over the investee.
However, under the notion of power in AASB 10, an investor could have power over an investee
if it held less than 50% of the voting power of the investee, and even, in some cases, if it had no
equity ownership at all. These types of situation in which the investor has power only without a
majority of voting rights is often called defacto power. Clearly, in such situations, the sound exercise
of professional judgement is paramount and the facts in each case need to be carefully assessed.
Paragraphs B41-B45 provide specific guidance on other factors and circumstances that should
be considered when assessing the existence of de facto control. In general, evidence should be
gathered as to whether there are sufficient rights held by other parties that could act as a counter-
veiling power to that held by the investor. For instance, if M Ltd only held 40% of the voting shares
of N Ltd but all the other shareholders of N Ltd only held small amounts of N Ltd's shares and
never attended N Ltds annual general meeting (AGM), these facts would suggest that M Ltd has
defacto power of N Ltd. This is because there is no evidence to suggest that the other shareholders
in N Ltd could form a cohesive group to out vote M Ltd. None of these other shareholders have
shareholdings greater than M Ltd and none of them show any interest in exercising their voting
rights because they do not attend N Ltd's AGM. A discussion of defacto power also highlights that
the investors control over an investee could be temporary. For example, M Ltds de facto control
of N Ltd is dependent on there being no coalition between the other shareholders in N Ltd. It is
possible, however, that during the year, the other shareholders sell their holdings to O Ltd with the
result that O Ltd gains 60% of the voting power in N Ltd and so can out vote M Ltd. As a result
M Ltd no longer has power over N Ltd once O Ltd gains its shareholding. Note that, provided the
other components of the control definition have been satisfied, M Ltd would still be required to
consolidate N Ltd up to the date that M Ltd lost control. The existence of so-called 'temporary
contror does not exempt the investor from consolidating the investee for the period of time that
control existed.

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 Some types of rights that are held by an entity are ‘protective’ rights rather than substantive
rights. AASB 10A defines protective rights as:
Rights designed to protect the interest of the party holding those rights without
giving that party power over the entity to which those rights relate.
Examples of protective rights are given in paragraph B28 of AASB 10 and include the right
of a lender to seize any assets from a borrower if the borrower breaches specific provisions of its
loan contract. Protective rights can be common in the not-for-profit sector where governments, for
example, may place a variety of restrictions on the activities of some charities or other entities.
As noted by the definition, protective rights are not a basis for establishing power over an investee
for the purposes of AASB 10.

1.7.4 Exposure or rights to variable returns

The second component of the control definition requires that the investor entity’s own returns
be potentially affected by its involvement in the investee. The returns must potentially be
variable rather than fixed or in other words the returns from the investee depend upon the
investee’s performance (AASB 10B56). AASB 10’s definition of control adopted the term
‘returns’ rather than the term ‘benefits’， which had been used in the prior version of AASB 127,
because it was discovered that some investors were seeking to avoid consolidating loss-making
subsidiaries by arguing that the losses were not benefits to the investor! The term ‘returns’ was
adopted because returns can be both positive and negative (AASB 10B.56). Some examples of
potential returns from the investee to the investor are provided in paragraph B57 of AASB 10
and include, but are not limited to, dividends, the ability to obtain resources not available to
other parties (e.g., produce distribution channels or access to scarce raw materials, tax benefits
or economies of scale).

1.7.5 Link between power and returns

The third component of the control definition is that the investor has to be able to use its power
over the investee to impact the amount of return generated by the investee. That is, it is not
enough for the investor to be exposed to variable returns from the investee, it must be able also
to have the ability to interact with the investee in such a way that it affects how much return the
investee makes. This component of the control definition is especially important in the context
of our discussion of SPEs in Section 1.5.5. It was noted in that section that a bank, for instance,
may enter into a securitisation arrangement by creating an entity such as a trust that is placed on
'auto pilot*. A key component of the auto-pilot arrangement is that the management and decision­
making responsibilities for the trust's relevant activities is given by the bank to an 'independent*
entity, the trustee. The objective of the arrangement is to allow the bank to meet its securitisation
needs by transferring power over the trusts relevant activities to the third party trustee while at the
same time avoiding bringing the trust onto the group’s consolidated financial statements. These
types of situations are described in paragraph 18 of AASB 10 as ‘principal or agent’ arrangements;
that is, it must be determined whether the trustee is the principal investor entity for the trust or
whether the trustee is actually only acting as an agent on behalf of the bank (in other words, the
bank is the principal and the trustee is the agent). If it is decided that the bank is a principal, then it
has not transferred power over the SPE trust to the trustee and it will have to consolidate that SPE
trust into the group’s consolidated financial statements.

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 Paragraphs B58 to B75 provide implementation guidance on assessing whether a decision-maker
is acting as a principal or as an agent for another investor. Again, it is important to assess each case
on its own facts but paragraph B60 suggests that factors that should be considered include:
參 The scope of the decision-maker’s authority over the investee. If the decision-maker has
considerable freedom to make decisions about the relevant activities of the investee, then it is
more likely to be a principal.
參 What rights are held by other parties? For example, does another party have substantial and
unilateral rights to remove the decision-maker (so-called 'kick-out* rights) or must a number of
parties be required to act together before the decision-maker can be removed?
參 How is the remuneration of the decision-maker determined for its involvement in the investee?
If, for instance, the decision-maker's remuneration is largely independent of the returns
generated from the investee, then the decision-maker is more likely to be an agent rather than
a principal.
參 Does the decision-maker have financial interests other than remuneration in the investee that
expose the decision-maker to the variability in returns that would be experienced by a principal?
For example, what is the size, if any, of the decision-makers holding in the equity of the investee?
None of these factors in themselves is conclusive in determining whether a decision-maker is
a principal or an agent for another investor and it may be that in practice it will be necessary to
determine a decision-maker's status on the balance of a variety of factors.
In summary, the definition of control in AASB 10 requires the facts of each investor-investee
relationship to be analysed to determine whether the three components of control have been
satisfied; namely, does the investor have power to direct the relevant activities of the investee by
having the current ability to exercise substantive rights; is the investor exposed to variable returns
from its involvement with the investee; and does the investor have the ability to use its power over
the investee to potentially vary the amount of returns generated from the investee? If all three
of these components are satisfied, then the investor controls the investee and the investor must
prepare consolidated financial statements.

1.7.6 Investment entities

Section 1.5.3 noted the debate over whether entities that were involved in investment activities
(so-called ‘finance subsidiaries’） should be excluded from the consolidated financial statements of
a group. It was noted in that section that recent amendments to AASB 10 have provided a limited
exemption for certain investment entities that allows them not to consolidate their subsidiaries.
This exemption is briefly discussed in this section.
An investment entity is characterised by having a business purpose which is only to invest for
capital gains or investment income (such as interest or dividend revenue) or both (AASB 10.85B).
An investment entity is defined in AASB 10A and AASB 10.27 as an entity that:
a. Obtains funds from one or more investors for the purpose of providing those
investor(s) with investment management services;
b. Commits to its investor(s) that its business purpose is to invest funds solely for
returns from capital appreciation, investment income, or both; and
c. Measures and evaluates the performance of substantially all of its investments
on a fair value basis.

C H A P T E R 1 Text objectives and introduction to consolidation 31

Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
 AASB 10.31 states that a parent entity that determines that it is an investment entity does not
consolidate its subsidiaries (or apply the requirements of AASB 3 when those subsidiaries were
purchased) but rather it must measure its investment in those subsidiaries at fair value through
profit or loss following the requirements of AASB 9. One exception to paragraph 31 is contained
in paragraph 32, which requires the investment entity parent to consolidate those subsidiaries that
provide services to the investment entity’s investment activities.
The exemption provided in paragraph 32 is meant to apply only in a limited range of situations
as identified in the narrow definition of an investment entity. Paragraph 33 of AASB 10 indicates
that the exemption from consolidation does not extend to an investment entity's parent, if that
parent is not itself an investment entity. As an example, consider Figure 1.1 again. If Y Ltd was
an investment entity and also a reporting entity, then it would not prepare consolidated financial
statements with Y Ltd and Z Ltd combined (assuming that Z Ltd was not the exception mentioned
in paragraph 32). If we now further assume that X Ltd (Y Ltd^ parent) is an investment entity, then
X Ltd would not present consolidated financial statements. Rather it would show its investment in
Y Ltd at fair value through profit or loss. Note the loss of important information to the users of X
Ltd’s financial statements as a result of this exemption in AASB 10. Information about Z Ltd will
be difficult to determine because it is not directly observable. On the other hand, if X Ltd is not
an investment entity, then it will be required by paragraph 33 of AASB 10 to present consolidated
financial statements including Y Ltd and Z Ltd.
Section 1.5.3 noted that the exemption from consolidation provided to investment entities has
been criticised as being inconsistent with the underlying principles of consolidation and providing
unscrupulous managers with opportunities to avoid consolidation. At present, it is not yet possible
to determine whether the exemption has led to any significant reductions in the decision usefulness
of consolidated financial statements.

1.7.7 Control and the not-for-profit sector

Although the main focus of this book is upon companies in the for-profit private sector, issues in
consolidation are also highly applicable to entities in the not-for-profit sector. The not-for-profit
sector consists of entities in the public sector (the Commonwealth government, state governments
and local governments) and private sector entities of which there are many kinds including religious
institutions, charities, hospitals, nursing homes and so on.
AASB 10 is the Australian equivalent of IFRS 10. The IASB^ constitution indicates that it
promulgates its standards in the context of global capital markets and consequently the needs
of entities in the not-for-profit sector are not incorporated into IFRS 10 (and by default, AASB
10). However, in Australia, the AASB has a policy of 'transaction neutral* standards, which
means that the standards apply to both the for-profit and not-for-profit sectors. In the not-for-
profit context, many standards can be more difficult to understand or apply. For instance, with
their emphasis on non-financial outcomes, many not-for-profit entities struggle to understand
how language like ‘investor’ and ‘investee’ applies in their context. Aware of these problems, the
AASB commissioned research to investigate what implementation issues not-for-profit entities
were encountering in practice when they sought to identify ‘subsidiaries’ for financial reporting
purposes. The findings of this research are reported in Howieson (2013). A number of errors
and misunderstandings of the concept of control were identified amongst financial statement
preparers and other parties in the not-for-profit sector. For example, some entities believed
that they were controlled by another entity only if there was active day-to-day management of

32 A ccoun ting for Corporate C om binations and Associations

Copyright €> Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2017 — 9781488611520 — Arthur/Accounting for Corporate Combinations and Associations 8e
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 When as they saw a Squire in squallid weed,
Lamenting sore his sorowfull sad tyne,
With many bitter teares shed from his blubbred eyne.

To whom as they approched, they espide xiv

A sorie sight, as euer seene with eye;
An headlesse Ladie lying him beside,
In her owne blood all wallow’d wofully,
That her gay clothes did in discolour die.
Much was he moued at that ruefull sight;
And flam’d with zeale of vengeance inwardly,[246]
He askt, who had that Dame so fouly dight;
Or whether his owne hand, or whether other wight?

Ah woe is me, and well away[247] (quoth hee) xv

Bursting forth teares, like springs out of a banke,
That euer I this dismall day did see:
Full farre was I from thinking such a pranke;
Yet litle losse it were, and mickle thanke,
If I should graunt that I haue doen the same,
That I mote drinke the cup, whereof she dranke:
But that I should die guiltie of the blame,
The which another did, who now is fled with shame.

Who was it then (sayd Artegall) that wrought? xvi

And why?[248] doe it declare vnto me trew.
A knight (said he) if knight he may be thought,
That did his hand in Ladies bloud embrew,
And for no cause, but as I shall you shew.
This day as I in solace sate hereby
With a fayre loue, whose losse I now do rew,
There came this knight, hauing in companie
This lucklesse Ladie, which now here doth headlesse lie.

He, whether mine seem’d fayrer in his eye, xvii

Or that he wexed weary of his owne,
 Would change with me; but I did it denye;
So did the Ladies both, as may be knowne,
But he, whose spirit was with pride vpblowne,
Would not so rest contented with his right,
But hauing from his courser her downe throwne,
Fro me reft mine away by lawlesse might,
And on his steed her set, to beare her out of sight.

Which when his Ladie saw, she follow’d fast, xviii

And on him catching hold, gan loud to crie
Not so to leaue her, nor away to cast,
But rather of his hand besought to die.
With that his sword he drew all wrathfully,
And at one stroke cropt off her head with scorne,
In that same place, whereas it now doth lie.
So he my loue away with him hath borne,
And left me here, both his and mine owne loue to morne.

Aread (sayd he) which way then did he make? xix

And by what markes may he be knowne againe?
To hope (quoth he) him soone to ouertake,
That hence so long departed, is but vaine:
But yet he pricked ouer yonder plaine,
And as I marked, bore vpon his shield,
By which it’s easie him to know againe,
A broken sword within a bloodie field;
Expressing well his nature, which the same did wield.

No sooner sayd, but streight he after sent xx

His yron page, who him pursew’d so light,
As that it seem’d aboue the ground he went:
For he was swift as swallow in her flight,
And strong as Lyon in his Lordly might.
It was not long, before he ouertooke
Sir Sanglier; (so cleeped was that Knight)
Whom at the first he ghessed by his looke,
And by the other markes, which of his shield he tooke.

He bad him stay, and backe with him retire; xxi

Who full of scorne to be commaunded so,
The Lady to alight did eft require,
Whilest he reformed that vnciuill fo:
And streight at him with all his force did go.
Who mou’d no more therewith, then when a rocke
Is lightly stricken with some stones throw;
But to him leaping, lent him such a knocke,
That on the ground he layd him like a sencelesse blocke.

But ere he could him selfe recure againe, xxii

Him in his iron paw he seized had;
That when he wak’t out of his warelesse paine,
He found him selfe,[249] vnwist, so ill bestad,
That lim he could not wag. Thence he him lad,
Bound like a beast appointed to the stall:
The sight whereof the Lady sore adrad,
And fain’d to fly for feare of being thrall;
But he her quickly stayd, and forst to wend withall.

When to the place they came, where Artegall xxiii

By that same carefull Squire did then abide,
He gently gan him to demaund of all,
That did betwixt him and that Squire betide.
Who with sterne countenance and indignant pride
Did aunswere, that of all he guiltlesse stood,
And his accuser thereuppon defide:
For neither he did shed that Ladies bloud,
Nor tooke away his loue, but his owne proper good.

Well did the Squire perceiue him selfe too weake, xxiv
To aunswere his defiaunce in the field,
And rather chose his challenge off to breake,
Then to approue his right with speare and shield.
 And rather guilty chose him selfe to yield.
But Artegall by signes perceiuing plaine,
That he it was not, which that Lady kild,
But that strange Knight, the fairer loue to gaine,
Did cast about by sleight the truth thereout to straine.

And sayd, Now[250] sure this doubtfull causes right xxv

Can hardly but by Sacrament be tride,
Or else by ordele, or by blooddy fight;
That ill perhaps mote fall to either side.
But if ye please, that I your cause decide,
Perhaps I may all further quarrell end,
So ye will sweare my iudgement to abide.
Thereto they both did franckly condiscend,
And to his doome with listfull eares did both attend.

Sith then (sayd he) ye both the dead deny, xxvi

And both the liuing Lady claime your right,
Let both the dead and liuing equally
Deuided be betwixt you here in sight,
And each of either take his share aright.
But looke who does dissent from this my read,
He for a twelue moneths day shall in despight
Beare for his penaunce that same Ladies head;
To witnesse to the world, that she by him is[251] dead.

Well pleased with that doome was Sangliere, xxvii

And offred streight the Lady to be slaine.
But that same Squire, to whom she was more dere,
When as he saw she should be cut in twaine,
Did yield, she rather should with him remaine
Aliue, then to him selfe be shared dead;
And rather then his loue should suffer paine,
He chose with shame to beare that Ladies head.
True loue despiseth shame, when life is cald in dread.
Whom when so willing Artegall perceaued; xxviii
Not so thou Squire, (he sayd) but thine I deeme
The liuing Lady, which from thee he reaued:
For worthy thou of her doest rightly seeme.
And you, Sir Knight, that loue so light esteeme,
As that ye would for little leaue the same,
Take here your owne, that doth you best beseeme,
And with it beare the burden of defame;
Your owne dead Ladies head, to tell abrode your shame.

But Sangliere disdained much his doome, xxix

And sternly gan repine at his beheast;
Ne would for ought obay, as did become,
To beare that Ladies head before his breast.
Vntill that Talus had his pride represt,
And forced him, maulgre, it vp to reare.
Who when he saw it bootelesse to resist,
He tooke it vp, and thence with him did beare,
As rated Spaniell takes his burden vp for feare.

Much did that Squire Sir Artegall adore, xxx

For his great iustice, held in high regard;
And as his Squire him offred euermore
To serue, for want of other meete reward,
And wend with him on his aduenture hard.
But he thereto would by no meanes consent;
But leauing him forth on his iourney far’d:
Ne wight with him but onely Talus went.
They two enough t’encounter an whole Regiment.

FOOTNOTES:
[245] iv 1 Eirena 1596
[246] xiv 7 inwardly: 1609
[247] xv 1 weal-away 1609
[248] xvi 2 why, 1596
[249] xxii 4 selfe 1596, 1609
[250] xxv 1 now 1596
[251] xxvi 9 is] his 1609
 Cant. II.

Artegall heares of Florimell,

Does with the Pagan fight:
Him slaies, drownes Lady Munera[252],
Does race her castle quight.

Nought is more honorable to a knight, i

Ne better doth beseeme braue cheualry,
Then to defend the feeble in their right,
And wrong redresse in such as wend awry.
Whilome those great Heroes got thereby
Their greatest glory, for their rightfull deedes,
And place deserued with the Gods on hy.
Herein the noblesse of this knight exceedes,
Who now to perils great for iustice sake proceedes.

To which as he now was vppon the way, ii

He chaunst to meet a Dwarfe in hasty course;
Whom he requir’d his forward hast to stay,
Till he of tidings mote with him discourse.
Loth was the Dwarfe, yet did he stay perforse,
And gan of sundry newes his store to tell,
 As[253] to his memory they had recourse:
But chiefely of the fairest Florimell,
How she was found againe, and spousde to Marinell.

For this was Dony, Florimels owne Dwarfe, iii

Whom hauing lost (as ye haue heard whyleare)
And finding in the way the scattred scarfe,
The fortune of her life long time did feare.
But of her health when Artegall did heare,
And safe returne, he was full inly glad,
And askt him where, and when her bridale cheare
Should be solemniz’d: for if time he had,
He would be there, and honor to her spousall ad.

Within three daies (quoth hee[254]) as I do here, iv

It will be at the Castle of the strond;
What time if naught me let, I will be there
To doe her seruice, so as I am bond.
But in my way a little here beyond
A cursed cruell Sarazin doth wonne,
That keepes a Bridges passage by strong hond,
And many errant Knights hath there fordonne;
That makes all men for feare that passage for to shonne.

What mister wight (quoth he) and how far hence v

Is he, that doth to trauellers such harmes?
He is (said he) a man of great defence;
Expert in battell and in deedes of armes;
And more emboldned by the wicked charmes,
With which his daughter doth him still support;
Hauing great Lordships got and goodly farmes,
Through strong oppression of his powre extort;
By which he stil them holds, and keepes with strong effort.

And dayly he his wrongs encreaseth more, vi

For neuer wight he lets to passe that way,[255]
 Ouer his Bridge, albee he rich or poore,
But he him makes his passage-penny pay:
Else he doth hold him backe or beat away.
Thereto he hath a groome of euill guize,
Whose scalp is bare, that bondage doth bewray,
Which pols and pils the poore in piteous wize;
But he him selfe vppon the rich doth tyrannize.

His name is hight Pollente, rightly so vii

For that he is so puissant and strong,
That with his powre he all doth ouergo,
And makes them subiect to his mighty wrong;
And some by sleight he eke doth vnderfong.
For on a Bridge he custometh to fight,
Which is but narrow, but exceeding long;
And in the same are many trap fals pight,
Through which the rider downe doth fall through ouersight.[256]

And vnderneath the same a riuer flowes, viii

That is both swift and dangerous deepe withall;
Into the which whom so he ouerthrowes,
All destitute of helpe doth headlong fall,
But he him selfe, through practise vsuall,
Leapes forth into the floud, and there assaies
His foe confused through his sodaine fall,
That horse and man he equally dismaies,
And either both them drownes, or trayterously slaies.

Then doth he take the spoile of them at will, ix

And to his daughter brings, that dwels thereby:
Who all that comes doth take, and therewith fill
The coffers of her wicked threasury;
Which she with wrongs hath heaped vp so hy,
That many Princes she in wealth exceedes,
And purchast all the countrey lying ny
With the reuenue of her plenteous meedes,
Her name is Munera, agreeing with her deedes.

Thereto she is full faire, and rich attired, x

With golden hands and siluer feete beside,
That many Lords haue her to wife desired:
But she them all despiseth for great pride.
Now by my life (sayd he) and God to guide,
None other way will I this day betake,
But by that Bridge, whereas he doth abide:
Therefore me thither lead. No more he spake,
But thitherward forthright his ready way did make.

Vnto the place he came within a while, xi

Where on the Bridge he ready armed saw
The Sarazin, awayting for some spoile.
Who[257] as they to the passage gan to draw,
A villaine to them came with scull all raw,
That passage money did of them require,
According to the custome of their law.
To whom he aunswerd wroth, Loe[258] there thy hire;
And with that word him strooke, that streight he did expire.

Which when the Pagan saw, he wexed wroth, xii

And streight him selfe vnto the fight addrest,
Ne was Sir Artegall behinde: so both
Together ran with ready speares in rest.
Right in the midst, whereas they brest to brest
Should meete, a trap was letten downe to fall
Into the floud: streight leapt the Carle vnblest,
Well weening that his foe was falne withall:
But he was well aware, and leapt before his fall.

There being both together in the floud, xiii

They each at other tyrannously flew;
Ne ought the water cooled their whot bloud,
But rather in them kindled choler new.
 But there the Paynim, who that vse well knew
To fight in water, great aduantage had,
That oftentimes him nigh he ouerthrew:
And eke the courser, whereuppon he rad,
Could swim like to a fish, whiles he his backe bestrad.

Which oddes when as Sir Artegall espide, xiv

He saw no way, but close with him in hast;
And to him driuing strongly downe the tide,
Vppon his iron coller griped fast,
That with the straint his wesand nigh he brast.
There they together stroue and struggled long,
Either the other from his steede to cast;
Ne euer Artegall his griple strong
For any thing wold[259] slacke, but still vppon him hong.

As when a Dolphin and a Sele are met, xv

In the wide champian of the Ocean plaine:
With cruell chaufe their courages they whet,
The maysterdome of each by force to gaine,
And dreadfull battaile twixt them do darraine:
They snuf, they snort, they bounce, they rage, they rore,
That all the sea disturbed with their traine,
Doth frie with fome aboue the surges hore.
Such was betwixt these two the troublesome vprore.

So Artegall at length him forst forsake xvi

His horses backe, for dread of being drownd,
And to his handy swimming him betake.
Eftsoones him selfe he from his hold vnbownd,
And then no ods at all in him he fownd:
For Artegall in swimming skilfull was,
And durst the depth of any water sownd.
So ought each Knight, that vse of perill has,
In swimming be expert through waters force to pas.
Then very doubtfull was the warres euent, xvii
Vncertaine whether had the better side:
For both were skild in that experiment,
And both in armes well traind and throughly tride.
But Artegall was better breath’d beside,
And towards th’end, grew greater in his might,
That his faint foe no longer could abide
His puissance, ne beare him selfe vpright,
But from the water to the land betooke his flight.

But Artegall pursewd him still so neare, xviii

With bright Chrysaor in his cruell hand,
That as his head he gan a litle reare
Aboue the brincke, to tread vpon the land,
He smote it off, that tumbling on the strand
It bit the earth for very fell despight,
And gnashed with his teeth, as if he band
High God, whose goodnesse he despaired quight,
Or curst the hand, which did that vengeance on him dight.[260]

His corps was carried downe along the Lee, xix

Whose waters with his filthy bloud it stayned:
But his blasphemous head, that all might see,
He pitcht vpon a pole on high ordayned;
Where many years it afterwards remayned,
To be a mirrour to all mighty men,
In whose right hands great power is contayned,
That none of them the feeble ouerren,
But alwaies doe their powre within iust compasse pen.

That done, vnto the Castle he did wend, xx

In which the Paynims daughter did abide,
Guarded of many which did her defend:
Of whom he entrance sought, but was denide,
And with reprochfull blasphemy defide,
Beaten with stones downe from the battilment,
 That he was forced to withdraw aside;
And bad his seruant Talus to inuent
Which way he enter might, without endangerment.

Eftsoones his Page drew to the Castle gate, xxi

And with his iron flale at it let flie,
That all the warders it did sore amate,
The which erewhile spake so reprochfully,
And made them stoupe, that looked earst so hie.
Yet still he bet, and bounst vppon the dore,
And thundred strokes thereon so hideouslie,
That all the peece he shaked from the flore,
And filled all the house with feare and great vprore.

With noise whereof the Lady forth appeared xxii

Vppon the Castle wall, and when she saw
The daungerous state, in which she stood, she feared
The sad effect of her neare ouerthrow;
And gan entreat that iron man below,
To cease his outrage, and him faire besought,
Sith neither force of stones which they did throw,
Nor powr of charms, which she against him wrought,
Might otherwise preuaile, or make him cease for ought.

But when as yet she saw him to proceede, xxiii

Vnmou’d with praiers, or with piteous thought,
She ment him to corrupt with goodly meede;
And causde great sackes with endlesse riches fraught,
Vnto the battilment to be vpbrought,
And powred forth ouer the Castle wall,
That she might win some time, though dearly bought
Whilest he to gathering of the gold did fall.
But he was nothing mou’d, nor tempted therewithall.

But still continu’d his assault the more, xxiv

And layd on load with his huge yron flaile,
 That at the length he has yrent the dore,
And made way for his maister to assaile.
Who being entred, nought did then auaile
For wight, against his powre them selues to reare:
Each one did flie; their hearts began to faile,
And hid them selues in corners here and there;
And eke their dame halfe dead did hide her self for feare.

Long they her sought, yet no where could they finde her, xxv
That sure they ween’d she was escapt away:
But Talus, that could like a limehound winde her,
And all things secrete wisely could bewray,
At length found out, whereas she hidden lay
Vnder an heape of gold. Thence he her drew
By the faire lockes, and fowly did array,
Withouten pitty of her goodly hew,
That Artegall him selfe her seemelesse plight did rew.

Yet for no pitty would he change the course xxvi

Of Iustice, which in Talus hand did lye;
Who rudely hayld her forth without remorse,
Still holding vp her suppliant hands on hye,
And kneeling at his feete submissiuely.
But he her suppliant hands, those hands of gold,
And eke her feete, those feete of siluer trye,
Which sought vnrighteousnesse, and iustice sold,
Chopt off, and nayld on high, that all might them behold.

Her selfe then tooke he by the sclender[261] wast, xxvii

In vaine loud crying, and into the flood
Ouer the Castle wall adowne her cast,
And there her drowned in the durty mud:
But the streame washt away her guilty blood.
Thereafter all that mucky pelfe he tooke,
The spoile of peoples euill gotten good,
The which her sire had scrap’t by hooke and crooke,
And burning all to ashes, powr’d it downe the brooke.

And lastly all that Castle quite he raced, xxviii

Euen from the sole of his foundation,
And all the hewen stones thereof defaced,
That there mote be no hope of reparation,
Nor memory thereof to any nation.
All which when Talus throughly had perfourmed,
Sir Artegall vndid the euill fashion,
And wicked customes of that Bridge refourmed.
Which done, vnto his former iourney he retourned.

In which they measur’d mickle weary way, xxix

Till that at length nigh to the sea they drew;
By which as they did trauell on a day,
They saw before them, far as they could vew,
Full many people gathered in a crew;
Whose great assembly they did much admire.
For neuer there the like resort they knew.
So towardes them they coasted, to enquire
What thing so many nations met, did there desire.

There they beheld a mighty Gyant stand xxx

Vpon a rocke, and holding forth on hie
An huge great paire of ballance in his hand,
With which he boasted in his surquedrie,
That all the world he would weigh equallie,
If ought he had the same to counterpoys.
For want whereof he weighed vanity,
And hid his ballaunce full of idle toys:
Yet was admired much of fooles, women, and boys.

He sayd that he would all the earth vptake, xxxi

And all the sea, deuided each from either:
So would he of the fire one ballaunce make,
And one of th’ayre, without or wind, or wether:
 Then would he ballaunce heauen and hell together,
And all that did within them all containe;
Of all whose weight, he would not misse a fether.
And looke what surplus did of each remaine,
He would to his owne part restore the same againe.

For why, he sayd they all vnequall were, xxxii

And had encroched vppon others share,
Like as the sea (which plaine he shewed there)
Had worne the earth[262], so did the fire the aire,
So all the rest did others parts empaire.
And so were realmes and nations run awry.
All which he vndertooke for to repaire,
In sort as they were formed aunciently;
And all things would reduce vnto equality.

Therefore the vulgar did about him flocke, xxxiii

And cluster thicke vnto his leasings vaine,
Like foolish flies about an hony crocke,
In hope by him great benefite to gaine,
And vncontrolled freedome to obtaine.
All which when Artegall did see, and heare,
How he mis-led the simple peoples traine,
In sdeignfull wize he drew vnto him neare,
And thus vnto him spake, without regard or feare.

Thou that presum’st to weigh the world anew, xxxiv

And all things to an equall to restore,
In stead of right me seemes great wrong dost shew,
And far aboue thy forces pitch to sore.
For ere thou limit what is lesse or more
In euery thing, thou oughtest first to know,
What was the poyse of euery part of yore:
And looke then how much it doth ouerflow,
Or faile thereof, so much is more then iust to trow.
For at the first they all created were xxxv
In goodly measure, by their Makers might,
And weighed out in ballaunces so nere,
That not a dram was missing of their right,
The earth was in the middle centre pight,
In which it doth immoueable abide,
Hemd in with waters like a wall in sight;
And they with aire, that not a drop can slide:
Al which the heauens containe, and in their courses guide.

Such heauenly iustice doth among them raine, xxxvi

That euery one doe know their certaine bound,
In which they doe these many yeares remaine,
And mongst them al no change hath yet beene found.
But if thou now shouldst weigh them new in pound,
We are not sure they would so long remaine:
All change is perillous, and all chaunce vnsound.
Therefore leaue off to weigh them all againe,
Till we may be assur’d they shall their course retaine.

Thou foolishe Elfe (said then the Gyant wroth) xxxvii

Seest not, how badly all things present bee,
And each estate quite out of order goth?
The sea it selfe doest thou not plainely see
Encroch vppon the land there vnder thee;
And th’earth it selfe how daily its increast,
By all that dying to it turned be?[263]
Were it not good that wrong were then surceast,
And from the most, that some were giuen to the least?

Therefore I will throw downe these[264] mountaines hie, xxxviii

And make them leuell with the lowly plaine:
These towring rocks, which reach vnto the skie,
I will thrust downe into the deepest maine,
And as they were, them equalize againe.
Tyrants that make men subiect to their law,
 I will suppresse, that they no more may raine;
And Lordings curbe, that commons ouer-aw;
And all the wealth of rich men to the poore will draw.

Of things vnseene how canst thou deeme aright, xxxix

Then answered the righteous Artegall,
Sith thou misdeem’st so much of things in sight?
What though the sea with waues continuall
Doe eate the earth, it is no more at all:
Ne is the earth the lesse, or loseth ought,
For whatsoeuer from one place doth fall,
Is with the tide vnto an other brought:
For there is nothing lost, that may be found, if sought.

Likewise the earth is not augmented more, xl

By all that dying into it doe fade.
For of the earth they formed were of yore,
How euer gay their blossome or their blade
Doe flourish now, they into dust shall vade.
What wrong then is it, if that when they die,
They turne to that, whereof they first were made?
All in the powre of their great Maker lie:
All creatures must obey the voice of the most hie.

They liue, they die, like as he doth ordaine, xli

Ne euer any asketh reason why.
The hils doe not the lowly dales disdaine;
The dales doe not the lofty hils enuy.
He maketh Kings to sit in souerainty;
He maketh subiects to their powre obay;
He pulleth downe, he setteth vp on hy;
He giues to this, from that he takes away.
For all we haue is his: what he list doe, he may.

What euer thing is done, by him is donne, xlii

Ne any may his mighty will withstand;
 Ne any may his soueraine power shonne,
Ne loose that he hath bound with stedfast band.
In vaine therefore doest thou now take in hand,
To call to count, or weigh his workes anew,
Whose counsels depth thou canst not vnderstand,
Sith of things subiect to thy daily vew
Thou doest not know the causes, nor their courses dew.

For take thy ballaunce, if thou be so wise, xliii

And weigh the winde, that vnder heauen doth blow;
Or weigh the light, that in the East doth rise;
Or weigh the thought, that from mans mind doth flow.
But if the weight of these thou canst not show,
Weigh but one word which from thy lips doth fall.
For how canst thou those greater secrets know,
That doest not know the least thing of them all?
Ill can he rule the great, that cannot reach the small.

Therewith the Gyant much abashed sayd; xliv

That he of little things made reckoning light,
Yet the least word that euer could be layd
Within his ballaunce, he could way aright.
Which is (sayd he) more heauy then in weight,
The right or wrong, the false or else the trew?
He answered, that he would try it streight,
So he the words into his ballaunce threw,
But streight the winged words out of his ballaunce flew.

Wroth wext he then, and sayd, that words were light, xlv
Ne would within his ballaunce well abide.
But he could iustly weigh the wrong or right.
Well then, sayd Artegall, let it be tride.
First in one ballance set the true aside.
He did so first; and then the false he layd
In th’other scale; but still it downe did slide,
And by no meane could in the weight be stayd.
For by no meanes the false will with the truth be wayd.

Now take the right likewise, sayd Artegall, xlvi

And counterpeise the same with so much wrong.
So first the right he put into one scale;
And then the Gyant stroue with puissance strong
To fill the other scale with so much wrong.
But all the wrongs that he therein could lay,
Might not it peise; yet did he labour long,
And swat, and chauf’d, and proued euery way:
Yet all the wrongs could not a litle right downe way[265].

Which when he saw, he greatly grew in rage, xlvii

And almost would his balances haue broken:
But Artegall him fairely gan asswage,
And said; Be[266] not vpon thy balance wroken:
For they doe nought but right or wrong betoken;
But in the mind the doome of right must bee;
And so likewise of words, the which be spoken,
The eare must be the ballance, to decree
And iudge, whether with truth or falshood they agree.

But set the truth and set the right aside, xlviii
For they with wrong or falshood will not fare;
And put two wrongs together to be tride,
Or else two falses, of each equall share;
And then together doe them both compare.
For truth is one, and right is euer one.
So did he, and then plaine it did appeare,
Whether of them the greater were attone.
But right sate in the middest of the beame alone.

But he the right from thence did thrust away, xlix

For it was not the right, which he did seeke;
But rather stroue extremities to way,
Th’one to diminish, th’other for to eeke.
 For of the meane he greatly did misleeke.
Whom when so lewdly minded Talus found,
Approching nigh vnto him cheeke by cheeke,
He shouldered him from off the higher ground,
And down the rock him throwing, in the sea him dround.

Like as a ship, whom cruell tempest driues l

Vpon a rocke with horrible dismay,
Her shattered ribs in thousand peeces riues,
And spoyling all her geares and goodly ray,
Does make[267] her selfe misfortunes piteous pray.
So downe the cliffe the wretched Gyant tumbled;
His battred ballances in peeces lay,
His timbered bones all broken rudely rumbled,
So was the high aspyring with huge ruine humbled.

That when the people, which had there about li

Long wayted, saw his sudden desolation,
They gan to gather in tumultuous rout,
And mutining, to stirre vp ciuill faction,
For certaine losse of so great expectation.
For well they hoped to haue got great good,[268]
And wondrous riches by his innouation.
Therefore resoluing to reuenge his blood,
They rose in armes, and all in battell order stood.

Which lawlesse multitude him comming too lii

In warlike wise, when Artegall did vew,
He much was troubled, ne wist what to doo.
For loth he was his noble hands t’embrew
In the base blood of such a rascall crew;
And otherwise, if that he should retire,
He fear’d least they with shame would him pursew.
Therefore he Talus to them sent, t’inquire
The cause of their array, and truce for to desire.
But soone as they him nigh approching spide, liii
They gan with all their weapons him assay,
And rudely stroke[269] at him on euery side:
Yet nought they could him hurt, ne ought dismay.
But when at them he with his flaile gan lay,
He like a swarme of flyes them ouerthrew;
Ne any of them durst come in his way,
But here and there before his presence flew,
And hid themselues in holes and bushes from his vew.

As when a Faulcon hath with nimble flight liv

Flowne at a flush of Ducks, foreby the brooke,
The trembling foule dismayd with dreadfull sight
Of death, the which them almost ouertooke,
Doe hide themselues from her astonying looke,
Amongst the flags and couert round about.
When Talus saw they all the field forsooke
And none appear’d of all that raskall rout,
To Artegall he turn’d, and went with him throughout.

FOOTNOTES:
[252] Arg. 3 Momera 1596, 1609: corr. Hughes
[253] ii 7 As] And 1596
[254] iv 1 hee] she 1596
[255] vi 2 way; 1596
[256] vii 9 ouersight 1596
[257] xi 4 Who] Tho conj. Church: When Morris
[258] 8 loe 1596, lo 1609
[259] xiv 9 would 1609
[260] xviii 9 dight 1596
[261] xxvii 1 slender 1609 passim
[262] xxxii 4 earth] eare 1596
[263] xxxvii 7 be 1596
[264] xxxviii 1 those 1609
[265] xlvi 9 way] lay 1609
[266] xlvii 4 be 1596
[267] l 5 makes 1596
[268] li 6 good; 1596
[269] liii 3 strooke 1609
 Cant. III.

The spousals of faire Florimell,

where turney many knights:
There Braggadochio is vncas’d
in all the Ladies sights.

After long stormes and tempests ouerblowne, i

The sunne at length his ioyous face doth cleare:
So when as fortune all her spight hath showne,
Some blisfull houres at last must needes appeare;
Else should afflicted wights oftimes despeire.
So comes it now to Florimell by tourne,
After long sorrowes suffered whyleare,
In which captiu’d she many moneths did mourne,
To tast of ioy, and to wont pleasures to retourne.

Who being freed from Proteus cruell band ii

By Marinell, was vnto him affide,
And by him brought againe to Faerie land;
Where he her spous’d, and made his ioyous bride.
The time and place was blazed farre and wide;
And solemne feasts and giusts ordain’d therefore.
To which there did resort from euery side
 Of Lords and Ladies infinite great store;
Ne any Knight was absent, that braue courage bore.

To tell the glorie of the feast that day, iii

The goodly seruice, the deuicefull sights,
The bridegromes state, the brides most rich aray,
The pride of Ladies, and the worth of knights,
The royall banquets, and the rare delights
Were worke fit for an Herauld, not for me:
But for so much as to my lot here lights,
That with this present treatise doth agree,
True vertue to aduance, shall here recounted bee.

When all men had with full satietie iv

Of meates and drinkes their appetites suffiz’d,
To deedes of armes and proofe of cheualrie
They gan themselues addresse, full rich aguiz’d,
As each one had his furnitures deuiz’d.
And first of all issu’d Sir Marinell,
And with him sixe knights more, which enterpriz’d
To chalenge all in right of Florimell,
And to maintaine, that she all others did excell.

The first of them was hight Sir Orimont, v

A noble Knight, and tride in hard assayes:
The second had to name Sir Bellisont,
But second vnto none in prowesse prayse;
The third was Brunell, famous in his dayes;
The fourth Ecastor, of exceeding might;
The fift Armeddan, skild in louely layes;
The sixt was Lansack, a redoubted Knight:
All sixe well seene in armes, and prou’d in many a fight.

And them against came all that list to giust, vi

From euery coast and countrie vnder sunne:
None was debard, but all had leaue that lust.
 The trompets sound; then all together ronne.
Full many deedes of armes that day were donne,
And many knights vnhorst, and many wounded,
As fortune fell; yet litle lost or wonne:
But all that day the greatest prayse redounded
To Marinell, whose name the Heralds loud resounded.

The second day, so soone as morrow light vii

Appear’d in heauen, into the field they came,
And there all day continew’d cruell fight,
With diuers fortune fit for such a game,
In which all stroue with perill to winne fame.
Yet whether side was victor, note be ghest:
But at the last the trompets did proclame
That Marinell that day deserued best.
So they disparted were, and all men went to rest.

The third day came, that should due tryall lend viii
Of all the rest, and then this warlike crew
Together met, of all to make an end.
There Marinell great deeds of armes did shew;
And through the thickest like a Lyon flew,
Rashing off helmes, and ryuing plates a sonder,
That euery one his daunger did eschew.
So terribly his dreadfull strokes did thonder,
That all men stood amaz’d, and at his might did wonder.

But what on earth can alwayes happie stand? ix

The greater prowesse greater perils find.
So farre he past amongst his enemies band,
That they haue him enclosed so behind,
As by no meanes he can himselfe outwind.
And now perforce they haue him prisoner taken;
And now they doe with captiue bands him bind;
And now they lead him thence, of all forsaken,
Vnlesse some succour had in time him ouertaken.
It fortun’d whylest they were thus ill beset, x
Sir Artegall into the Tilt-yard came,
With Braggadochio, whom he lately met
Vpon the way, with that his snowy Dame.
Where when he vnderstood by common fame,
What euill hap to Marinell betid,
He much was mou’d at so vnworthie shame,
And streight that boaster prayd, with whom he rid,
To change his shield with him, to be the better hid.

So forth he went, and soone them ouer hent, xi

Where they were leading Marinell away,
Whom he assayld with dreadlesse hardiment,
And forst the burden of their prize to stay.
They were an hundred knights of that array;
Of which th’one halfe vpon himselfe did set,
The other[270] stayd behind to gard the pray.
But he ere long the former fiftie bet;
And from the other[271] fiftie soone the prisoner fet.

So backe he brought Sir Marinell againe; xii

Whom hauing quickly arm’d againe anew,
They both together ioyned might and maine,
To set afresh on all the other crew.
Whom with sore hauocke soone they ouerthrew,
And chaced quite out of the field, that none
Against them durst his head to perill shew.
So were they left Lords of the field alone:
So Marinell by him was rescu’d from his fone.

Which when he had perform’d, then backe againe xiii

To Braggadochio did his shield restore:
Who all this while behind him did remaine,
Keeping there close with him in pretious store
That his false Ladie, as ye heard afore.
Then did the trompets sound, and Iudges rose,
 And all these knights, which that day armour bore,
Came to the open hall, to listen whose
The honour of the prize should be adiudg’d by those.

And thether also came in open sight xiv

Fayre Florimell, into the common hall,
To greet his guerdon vnto euery knight,
And best to him, to whom the best should fall.
Then for that stranger knight they loud did call,
To whom that day they should the girlond yield.
Who came not forth, but for Sir Artegall
Came Braggadochio, and did shew his shield,
Which bore the Sunne brode blazed in a golden field.

The sight whereof did all with gladnesse fill: xv

So vnto him they did addeeme the prise
Of all that Tryumph. Then the trompets shrill
Don Braggadochios name resounded thrise:
So courage lent a cloke to cowardise.
And then to him came fayrest Florimell,
And goodly gan to greet his braue emprise,
And thousand thankes him yeeld, that had so well
Approu’d that day, that she all others did excell.

To whom the boaster, that all knights did blot, xvi

With proud disdaine did scornefull answere make;
That what he did that day, he did it not
For her, but for his owne deare Ladies sake,
Whom on his perill he did vndertake,
Both her and eke all others to excell:
And further did vncomely speaches crake.
Much did his words the gentle Ladie quell,
And turn’d aside for shame to heare, what he did tell.

Then forth he brought his snowy Florimell, xvii

Whom Trompart had in keeping there beside,
 Couered from peoples gazement with a vele.
Whom when discouered they had throughly eide,
With great amazement they were stupefide;
And said, that surely Florimell it was,
Or if it were not Florimell so tride,
That Florimell her selfe she then did pas.
So feeble skill of perfect things the vulgar has.

Which when as Marinell beheld likewise, xviii

He was therewith exceedingly dismayd;
Ne wist he what to thinke, or to deuise,
But like as one, whom feends had made affrayd,
He long astonisht stood, ne ought he sayd,
Ne ought he did, but with fast fixed eies
He gazed still vpon that snowy mayd;
Whom euer as he did the more auize,
The more to be true Florimell he did surmize.

As when two sunnes appeare in the azure[272] skye, xix

Mounted in Phœbus charet fierie bright,
Both darting forth faire beames to each mans eye,
And both adorn’d with lampes of flaming light,
All that behold so strange prodigious sight,
Not knowing natures worke, nor what to weene,
Are rapt with wonder, and with rare affright.
So stood Sir Marinell, when he had seene
The semblant of this false by his faire beauties Queene.

All which when Artegall, who all this while xx

Stood in the preasse close couered, well aduewed,
And saw that boasters pride and gracelesse guile,
He could no longer beare, but forth issewed,
And vnto all himselfe there open shewed,
And to the boaster said; Thou losell base,
That hast with borrowed plumes thy selfe endewed,
And others worth with leasings doest deface,
When they are all restor’d, thou shalt rest in disgrace.

That shield, which thou doest beare, was it indeed, xxi

Which this dayes honour sau’d to Marinell;
But not that arme, nor thou the man I reed,
Which didst that seruice vnto Florimell.
For proofe shew forth thy sword, and let it tell,
What strokes, what dreadfull stoure it stird this day:
Or shew the wounds, which vnto thee befell;
Or shew the sweat, with which thou diddest sway
So sharpe a battell, that so many did dismay.

But this the sword, which wrought those cruell stounds, xxii
And this the arme, the which that shield did beare,
And these the signes, (so shewed forth his wounds)
By which that glorie gotten doth appeare.
As for this Ladie, which he sheweth here,
Is not (I wager) Florimell at all;
But some fayre Franion, fit for such a fere,
That by misfortune in his hand did fall.
For proofe whereof, he bad them Florimell forth call.

So forth the noble Ladie was ybrought, xxiii

Adorn’d with honor and all comely grace:
Whereto her bashfull shamefastnesse ywrought
A great increase in her faire blushing face;
As roses did with lillies interlace.
For of those words, the which that boaster threw,
She inly yet conceiued great disgrace.
Whom when as all the people such did vew,
They shouted loud, and signes of gladnesse all did shew.

Then did he set her by that snowy one, xxiv

Like the true saint beside the image set,
Of both their beauties to make paragone,
And triall, whether should the honor get.
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