The Revised SFAS 7: Key Points and Probable Effects

With more and more Taiwanese manufacturers setting up factories in Mainland China in recent years, investors naturally become concerned that the resulting multi-tiered corporate investment structures - holding companies, subsidiaries and often sub-subsidiaries - come at the cost of compromised transparency.

If consolidated financial statements were the norm here, and separate financial statements the exception, it would be easier to get a look at the whole picture of a conglomerate's operations. It would also be consistent with the direction international trends are hastening.

To further harmonize domestic accounting standards with global GAAP, Taiwan's Accounting Research and Development Foundation completed an overhaul of its Statement of Financial Accounting Standards No. 7 (SFAS 7), on "Consolidated Financial Statements". The Securities and Futures Bureau also issued an order requiring public (exchange-listed and OTC-traded) companies to submit joint, consolidated financial statements, beginning in 2005 when they publicly file midyear financial reports. This article offers readers a look at SFAF 7's major revisions and their impact, comparing the situation before and after those revisions, in the hopes that it will help companies respond early and with care.

The criteria for including a "subsidiary" in the consolidated financial statement will no longer be that more than 50% of the invested company's stock is held, and will instead depend on whether or not effective economic control is exercised over the invested company.

Therefore, as for the past practice of arranging shareholding proportions so that invested companies would not be incorporated in consolidated statements, one can anticipate that it will not be seen again. That being the case, the complexity and cost of compiling consolidated statements is bound to increase.

Further limiting the subsidiaries that can be omitted from the consolidated statement, conditions were deleted from the new rules under which companies could be left out in the past - where the subsidiary is in an unrelated line of business, is small-scale, etc. In other words, all such subsidiaries will have to be brought into the consolidated statement.

Part of the procedures for compiling consolidated statements have been changed; a selection of the more important changes are explained below:

• When control over a subsidiary is acquired over the course of a year, the consolidated profit and loss statement may only include the revenue earned and costs/losses incurred by the subsidiary after the acquisition date, rather than recognizing them as of the beginning of the period that a controlling interest is acquired in the subsidiary. Similarly, when control over a subsidiary is lost during the year, its revenues and costs/losses up to the date that control is lost must be included in the profit and loss statement, and may not be left out of the consolidated statement.
• In principle, when a parent company and its subsidiary have different accounting years, it is a mandatory requirement that the subsidiary follow the accounting year of the parent company, and that the separately prepared financial statements be consolidated.
• In the consolidated financial statement, the unamortized difference between the amount paid for an equity investment and the net value of the equity is no longer to be expressed as "consolidated borrowing (loan) items". Instead, it reverts to SFAS 25 "Accounting Treatment of Mergers and Acquisitions", which says that, for the difference between the amount paid for an equity investment and the net value of the equity, you must first identify in which of the subsidiary's assets differences have arisen between net asset (fair) values and book values. Any remaining balance is initially recorded as goodwill or deferred credits (negative goodwill).
• The conditions that must be met to be able to forego compilation of a consolidated financial statement are explicitly stipulated.
• It is also clearly stipulated that, when an enterprise applies the amended SFAS 7 for the first time, there is no retroactive recompilation of previous-year statements. But if there are changes in accounting principles, the cumulative effect of those changes must be stated separately in the profit and loss statement for the current period.

• To be consistent with the revised part of SFAS 7 concerning standards for identifying controlled invested companies, article 5 in "Accounting Treatment of Long-term Equity Investment" was revised in so far as it deals with guidelines and standards for identifying controlled invested companies.
  
  The appropriation of unrealized gains and losses generated due to transactions between parent companies and subsidiaries will now depend on whether or not the invested company has control over the invested company.
  
  If the investing company has effective control over the invested company, then all unrealized gains and losses between the companies must be eliminated (i.e., taken by the investing company). If the investing company lacks the ability to control the invested company, the unrecognized gains and losses between the companies must be allocated in proportion to end-of-period percentage share ownership.
  
  Hence, the most significant effect of this amendment is on the future recording of unrealized gains and losses between companies: It is possible that a variation in the standards for identifying effective control could cause accounting treatment to differ from previous years.

• If the investing company has garnered a controlling interest, except where other shareholders of the invested company have obligations, and can provide additional funds to cover its losses, the investing company must otherwise absorb all losses in excess of the original equity of the invested company's shareholders.
  
  In other words, in situations where the investing company identifies its ability to control an invested company, we can say farewell to the accounting treatment used heretofore, whereby investment losses could be entered under the book value balances of long-term investments and advances, taken down to zero.

• Previously, where less than 50% of the invested company's voting shares were owned, if the invested company's statements could not be obtained in the same period, then when they were obtained in the next period, investment gains/losses could be recorded in proportion to the equivalent shareholding percentage in the previous period. This rule has been eliminated.
  
  In other words, beginning with 2005, investment gains and losses must all be taken in the current period, using the equity method, and one cannot postpone recognizing them until the following period.