 But hello and welcome to this session in which we will discuss the concept of internal control when it comes to consolidated financial statements. Here's what we know. If one company exercise control over another company, then you consolidate the financial statements and the process is called financial statement consolidation. Now, when do you have control? Well, when you own more than 50% of the other company stocks, if you own more than 50% specifically of their voting stock, then you have some sort of a control. Now, how is that control? How does it manifest itself? Well, if you have more than 50% of their voting stock, you can tell the company what to do because you control the largest blocks of votes. It means here you have control and specifically you have direct control. So you own 50% more than 50%. Let me show you this in a picture. You have a parent company or a company that owns 60% of another company. Well, if you own more than 60% of the subsidiary, you control that subsidiary. This is called direct control. Pretty straightforward. You have more than 50%. Then the sub will have to consolidate their financial statements with the parent company. Now, the parent company could have control for more than one subsidiary. So they can control 78% of sub A and 85% of sub B. Well, basically, A and B will have to be consolidated with A. Basically, A controls both of them. This again, this is called direct control. Pretty straightforward. You can clearly see it if you own more than 50%. How about when we have indirect control? Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Myles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. Well, what is indirect control? Well, think of when one company owned by one or more other companies that under the common control of one company. Think of a pyramid. This is what indirect control looks like. So let me show you in a picture what it looks like. So you have a parent company that owns 55% of sub A. Well, if you own more than 50%, you control sub A. It means A will have to be consolidated with B because B is in control. Pretty straightforward. Now, what happened if A also sub A controls 60% of sub B? Well, guess what? Now, the parent company can do what? The parent company controls A and since they control A, they can tell A what to do. And A can tell B what to do because A controls 60% of B. So in reality, A controls B indirectly. They don't own any shares in B directly, but they own shares in A, which controls B. In the real world, if you think about it, I'm sure you heard of Google, right? So Google owns Alphabet. So Google is here. So Alphabet is here. Alphabet controls Google. Then Google controls YouTube. Most likely you might be watching this on some sort of a video, YouTube. So Alphabet controls YouTube through Google. So this is basically how it works. Another way of saying this is we have a grandson, which is YouTube is the grandson. Father, we have a father and grandfather. So we have a grandfather, son, grandson relationship. This is what we have here. Grandfather, son, grandson relationship. Now, this indirect control could take place in many different ways. Let me show you another format of it. We have a parent company that owns 62% of sub A. They control sub A. They also control 70% of sub B. They control sub B. Now, sub B owns 35% and sub C. Now, sub B doesn't control sub C because they own only 35%. But here's what happened. Also, sub A owns 20% of sub C. Also, they don't control sub C. They basically A and B use equity method when they account for C. However, if we look at the parent company here, the parent company can tell A what to do because they control A. They can tell B what to do. They control B. Now, A, they only have 20% power over C. Well, they cannot tell C what to do. But the parent company, they also control B, which own 35% of C. Well, if you think of it, the parent company can tell A and B what to do. And A and B put together will represent 55% of the stock of C. Simply put, the parent company controls C. So notice how the control is here. It's basically two layer. Now, we could have other sources of control. I'll show you one later on. But the point is you have to consolidate when you have control. Now, you do not consolidate if the sub is in bankruptcy. Why? Because if the sub is in bankruptcy, the owners of the company don't have control. The court would assign either a judge or a trustee to run the company. Therefore, you don't consolidate. Or if the subsidiary under the control of a foreign country, for example, they operate in a foreign country, in a foreign country, tell them what to do or what not to do it specifically. For example, they cannot take the cash out of that country because it's controlled by that country. Then you cannot consolidate. Also, we could have consolidation issues when there are different physical period might complicate the process between the sub and the parent company. Usually in the real world, when that happened, the sub will basically change their physical to match the parent, whether the parent is a physical or a calendar. That's what could happen. Or the sub will have two physical period, one to consolidate with the parent and one for themselves. Again, the process gets complicated. Now, bear in mind, if you don't consolidate, what you have is a single line investment in the company. So if you don't consolidate for one reason or another, basically the sub becomes an investment for you. Now, let me show you another indirect control. Basically, we have a parent company and they control, let's assume of A, they control 70% of A. Well, they control A. A controls B and let's assume A controls 60% of V. Now, the parent don't control B directly, but they control it, they control it indirectly. Now we have C and we have sub E. Now, if let's assume B owns 15% of C. Well, the parent has control of V, but B does not have any control of C. Therefore, the parent doesn't have control of C. Now let's assume A controls 25% of C. Well, although A controls 25% of C, we control A, we control B. Together, they only give us 40%, so the parents still don't control C. Let's assume we have another subsidiary, E, and we own 80% of E. Now, E owns a small percentage of C, 12%. Now, here's what happened. The parent company controls B, the parent company controls A, the parent company controls E, and B, A, and E, they all have some sort of an ownership in C, 15, 25, which will make it 40 plus 12 equal to 52%. At this point, the parent company will control C. Now, why am I showing you this? The point I'm trying to make here is this. Indirect control gets very complicated, many layers, and this is what happened when the people wants to basically, companies wants to hide money, hide relationship, that's what they do. They build those relationships where one company controls the other, the other one controls the other, so on and so forth. This is still very simple structure. The point is it gets very, very complicated in the real world. Let's take a look at this multiple choice question. P owns 53% of X and 70% of Y, so we have P, we have X, and we have Y. So we own 53% of X, 70% of Y. Do we own X? Do we control X? Yes. Do we control Y? Yes. If X and Y jointly own 100% of Z, so X and Y, you know, I don't know, it could be 50, 50, 60, 40, it doesn't matter, but they both control, they have control of Z. Under what circumstances would P would not be deemed in control of Z? So right now, is it in control of Z? And the answer is yes, because P can control X, P can control Y, and X and Y control Z, therefore P controls Z. But is there a circumstances where P does not control Z? Well, let's take a look at the answer choices. Z is an insurance company. We're not told anything about whether it's an insurance company or not. Z is in chapter 11 bankruptcy. Well, if Z in a bankruptcy, chapter 11, guess what? Someone else controls the, some judge or a trustee is signed by a court. So B is a good answer. P is not in control of Z. No, P is in control of Z from a controlled perspective, in control perspective, but it's not in control Y. That's what we're kind of, I'm telling you it's not in control, but Y. So basically C is not an answer because I already told you it's not in control, just made up this answer. The CEO of Z was a former executive of P. It doesn't matter. Even if they were a former executive, there's no such thing as related party cannot consolidate or anything like that. So the answer is, if Z is in chapter 11 bankruptcy, then what happened under those circumstances, the owners of Z, basically they lost control. The owners means X and Y lost control because now the judge or the trustee is in charge of their liquidation. Therefore they're not in control of the company. Therefore P is not in control of the company because they are in chapter 11 bankruptcy. What should you do now? Go to Farhat Lectures, look at additional resources that's going to help you with your advanced accounting, CPA exam preparation, whatever you are preparing for. Good luck, study hard, and of course stay safe.