The need for consolidated financial statements Imagine being a shareholder of P Ltd from Section 16.2.

Each year you would rece ive a set of P Ltd s financial statements. After P s acquisition of the shares in S Ltd, 60,000 would appear as an asset in the balance sheet of P Ltd. It would be n ormal for it to be shown at cost (i.e. 60,000) thus observing the historical cost concept. When you look at the profit and loss account of P Ltd you would see the dividend s received from S Ltd. This, and the cost of the investment in the balance sheet would be the only things you would know about the subsidiary. However, you have invested in P Ltd, and because of its majority shareholding in S Ltd you have, in effect, also invested in S Ltd. Being consistent, if you want to know h ow the assets and liabilities in P Ltd change over the years, you will now also like to know exact ly the same for S Ltd. You are not, however, a shareholder of S Ltd, and would not be sent a copy of it s financial statements. As a result, you would not have any right to any further information about S Ltd. This would be even worse if P Ltd, for example, had twenty subsidiaries and held a different percentage stake in each of them. It would also be almost certain that the compa nies would trade with each other, and owe money to one another or be owed money by them. This wou ld also raise complications and make it hard for you to see what was truly happening acr oss the group. This would, clearly, be less than ideal. There is a remedy for this sort of problem. The Companies Acts seek to overcome this type of situation by requiring that parent undertakin gs distribute to their shareholders a set of consolidated financial statements. This is known as consolidated accounting. These bring together all of the financial statements for the parent undertaking and its subsidiaries in such a way that the shareholders can get an overall view of their investments. You will learn more about consolidated financial statements in Section 16.7. 16.5 Different methods of acquiring control of one company by another The acquisition of control in S Ltd by P Ltd involved P Ltd buying more than 50 per cent of the shares in S Ltd from Jones. This is by no means the only way of acquiring control. Other methods of doing so include: 1 S Ltd may issue new shares to P Ltd amounting to over 50 per cent of the voti ng shares. P Ltd pays for the shares in cash. 2 P Ltd could purchase over 50 per cent of the voting shares of S Ltd on the op en market by exchanging for them newly issued shares of P Ltd. Or, acting through another company: 3 P Ltd acquires more than 50 per cent of the voting shares in S1 Ltd for cash, and then S1 Ltd proceeds to acquire all of the voting shares of S2 Ltd. S2 Ltd would the n be a sub-subsidiary of P Ltd. These are only some of the more common ways by which one company becomes a subsi diary of another company.

16.6 Control by dominant influence The issue of FRS 2 in 1992 introduced a further way of looking at whether or not one company has control of another. It states that if one company has the right to exercise a dominant Chapter 16 l Group financial statements: an introduction influence over another undertaking, then the company with the dominating influenc e is deemed to have control of the other. It is not necessary to have over 50 p er cent of the voting share capital of a company in order to be able to exercise a dominant influence. A dominant influence means that the holder of it has a ri ght to give directions with regard to the operating and financial policies of an other undertaking, and that the directors of that latter undertaking are obliged to follow those directions, whether or not the directors consider that those di rections are for the benefit of the undertaking. In other words, if one undertaking can tell another undertaking what to do, both from an operating and a financial point of view, and the directors of that latt er undertaking have to carry out such instructions, then such an undertaking wil l be a subsidiary undertaking. This is a much wider definition than merely looki ng at the amounts of the shareholdings.