Is the consolidation of accounts required, if a company holds less than 20% of the paid-up capital of another company?

Q: XYZ Ltd has a total paid-up share capital consisting of 100,000 shares, each with a face value of Rs. 10. ABC Ltd, a listed company, owns 1,000 equity shares of XYZ Ltd, while PQR Ltd holds 9,000 preference shares. The question is, whether ABC Ltd should consolidate the financial statements of XYZ Ltd into its own books of accounts?

APPLICABLE SECTIONS AND ACCOUNTING STANDARDS:

WHEN SHOULD A COMPANY CONSOLIDATE ITS BOOKS OF ACCOUNTS?

SECTION 129(3)

(3) Where a company has one or more subsidiaries or associate companies, it shall, in addition to financial statements provided under sub-section (2), prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with applicable accounting standards, which shall also be laid before the annual general meeting of the company along with the laying of its financial statement under sub-section (2).

ASSOCIATE COMPANY DEFINITION

Sec 2(6)- Definition of Associate Company: -

 “Associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.

Explanation —For the purposes of this clause, —

(a) the expression “significant influence” means control of at least twenty per cent. of total voting power, or control of or participation in business decisions under an agreement;

(b) the expression "joint venture" means a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement;

WHAT IS VOTING POWER?

Sec 2(89)- Definition of “total voting power”: -

 “Total voting power”, in relation to any matter, means the total number of votes which may be cast in regard to that matter on a poll at a meeting of a company if all the members thereof or their proxies having a right to vote on that matter are present at the meeting and cast their votes;

WHAT ARE VOTING RIGHTS OF SHAREHOLDERS?

Voting rights for:

i) Equity shareholder: -Sec 47(1) - have a right to vote on every resolution placed before the company; and

ii) Preference shareholder: - Sec 47(2) -have a right to vote only on resolutions placed before the company which directly affect the rights attached to his preference shares, any resolution for the winding up of the company or for the repayment or reduction of its equity or preference share capital:  that where the dividend in respect of a class of preference shares has not been paid for a period of two years or more, such class of preference shareholders shall have a right to vote on all the resolutions placed before the company.

WHAT IS SIGNIFICANT INFLUENCE DEFINED IN ACCOUNTING STANDARDS?

IND AS 128 -Significant influence

 If an entity holds, directly or indirectly (eg through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the entity holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the entity does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an entity from having significant influence.

• ANALYSIS:

On analyzing all the above mentioned, we can understand the following:-

1. Associate Companies need to be consolidated.
2. Associate Companies applicability is only based on voting power and not paid up capital.
3. Total voting power in a meeting of a company is only based on equity shares.
4. Preference Shareholders can vote only on resolutions mentioned under 47(2).
5. According to Ind AS 128 significant influence is based on voting power only.

• CONCLUSION:

Based on the above analysis, it is clear that a company can be considered an associate company only when there is 20% or more equity shareholding, making consolidation applicable.

If a company holds even 1% of the paid-up capital, and within that 1%, a company holds 20% of the equity, then consolidation becomes applicable.

Therefore, I conclude that the consolidation of associates is determined by equity shareholding, not by paid-up share capital.

Hence, ABC Ltd should consolidate the financial statements of XYZ Ltd into its own books of accounts.

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