Determining the scope of consolidation

The scope of consolidation: the concepts of control, of control percentage and interest percentage

Determining

First consolidation - determining the scope of consolidation

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This article is the second in a series on topics about account consolidation. Taken together, the upcoming articles will help you understand the different steps of the consolidation process as well as the importance of working with professionals and of investing in effective, modern software applications.

The process of determining the scope of consolidation is not immune from the diversity of accounting standards. The items covered in this article are based on IFRS rules. Defining the scope is probably the most significant task of the overall process for the simple reason that it determines which companies in the group will be consolidated and which method will be used.

We should point out that the use of consolidation software can greatly facilitate the calculation of control and interest percentages and the accounting application of ad hoc consolidation methods.

There are four categories of holdings:

  • Direct holdings (1)
  • Indirect holdings (2)
  • Cross holdings (3)
  • Circular holdings (4)

The concept of control percentage

Allocation of a level of control to each company included in the scope and, therefore, of a consolidation method, requires calculation of the control percentage.

The control percentage is the cumulative percentage of voting rights held and, under certain conditions, potentially held, by the consolidating entity, either directly or indirectly. Indirectly means via the intermediary of entities under exclusive control. This percentage is only useful for the determination of the scope and of the consolidation method. The latter is a necessary criterion but is not sufficient since de facto situations and contractual arrangements can contradict the first conclusions of control percentages with respect to the level of control.

Different consolidation methods are used depending on the level of control:

  • Exclusive control → Full consolidation
  • Joint control → Proportionate consolidation or equity method
  • Significant influence → Equity method

In brief, full integration consists in including the entire balance sheet and profit and loss account of the consolidated entity in the consolidated accounts after required adjustments and eliminations. The portion of shareholders’ equity and of income which do not belong to the consolidated entity will be allocated to minority interests. Proportionate integration includes the balance sheet and the income account of the consolidated entity but only up to the level held by the consolidating company. The equity method consists in substituting the book value of the securities held with the share of shareholders’ equity of the equity-accounted entity.

In all three methods, the difference between the cost of acquisition of the holding and the total value of its assets and liabilities on the date of acquisition is either “goodwill” (positive acquisition difference) or “badwill” (negative acquisition difference).

The concept of interest percentage

The interest percentage, which may be different from the control percentage, enables calculation of the share of assets held directly or indirectly by the mother company in the different companies of the group. The calculation process is different because, contrary to the control percentage, the interest percentage is obtained by using the sum of the percentages of financial rights held. Contrary to some other GAAP, international standards stipulate that only interest percentages held indirectly by subsidiaries must be included in the percentage calculation. We now know a little more about the concepts of control and control and interest percentages.

What to expect from consolidation software

In conclusion, we should point out that using good consolidation software enables maximum automation of scope determination, of the calculation of control and interest percentages, of consolidation methods and of the resulting accounting processing. Adjustment to methods as a result of new elements in the scope and the management of scope simulations are also greatly facilitated.