On 12th May 2011, the IASB issued its new suite of consolidation and related standards, replacing the existing accounting for subsidiaries and joint ventures (now joint arrangements), and making limited amendments in relation to associates. In this article we focus on IFRS 10 Consolidated Financial Statements
and IAS 27 (2011) Separate Financial Statements, giving our perspectives on the requirements that are modified and that are expected to have an impact on the preparers and users of IFRS financial statements.
New suite of standards
Key
IFRS 10 Consolidated Financial Statements ? IFRS 11 Joint Arrangements
IFRS 12 Disclosure of Interests in Other Entities
IAS 27 (2011) Separate Financial Statements
IAS 28 (2011) Investments in Associates and Joint Ventures
IFRS 10 supersedes IAS 27 Consolidated and Separate Financial Statements and SIC-12 Consolidation — Special Purpose Entities; while the requirements of IAS 27 (2008) relating to the separate financial statements are retained in IAS 27 (2011).
Change in control criteria In a nutshell, IFRS 10 provides similar guidance in relation to the exemptions from preparing consolidated financial statements and the consolidated procedures as contained in IAS 27 (2008); the major change introduced by IFRS 10 is in relation to the definition of control over the investee.
The definition of a subsidiary under IAS 27 (2008) focusses on the concept of control and has two parts, both of which need to be met in order to conclude that one entity controls another, i.e., (a) the power to govern the financial and operating policies of an entity, and (b) to obtain benefits from its activities.
Under IFRS 10, an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Thus, an investor controls an investee if the investor has all the following:
(a) power over the investee;
(b) exposure, or rights, to variable returns from its involvement with the investee; and
(c) the ability to use its power over the investee to affect the amount of the nvestor’s returns.
The exposure to risks and rewards of an investee does not on its own, determine that the investor has control over an investee; it is one of the factors of the control analysis.
Control is assessed on a continuous basis, i.e., it is reassessed as facts and circumstances change. A change in market conditions does not trigger a reassessment of the control conclusion unless it changes one or more of the elements of control (e.g., whether potential voting rights are substantive).
In assessing control over an investee, the investor considers the purpose and design of the investee so as to identify the investee’s relevant activities, how decisions about such activities are made, who has the current ability to direct those activities and who receives returns therefrom.
New single control model
IFRS 10 requires the investor to assess control over the investee, which is a separate legal entity. However, in certain cases, the investor may acquire control over specified assets and liabilities of an entity, such that those specified assets and liabilities may be considered as a deemed separate entity. Such deemed entities are referred to as ‘Silo’ for the purpose of applying the consolidation standard. Specified assets and liabilities qualify as ‘Silo’ if:
In substance, the assets, liabilities and equity of the silo are separate from the overall entity such that none of those assets can be used to pay other obligations of the entity and those assets are the only source of payment for specified liabilities of the silo; and
Parties other than those with the specified liability, have no rights or obligations related to the specified assets or residual cash flows from those assets.
Where one party controls a silo, the other parties exclude the silo when assessing control over the separate legal entity.
Key changes from IAS 27 (2008)
Under IAS 27 (2008), control under is assessed at the level of the separate legal entity; whereas under IFRS 10, the control may also be assessed at the level of silo.
Identify the relevant activities of the investee
For the purpose of IFRS 10, the term ‘relevant activities’ imply activities of the investee that significantly affect the investee’s returns.
Range of activities
For many investees, a range of operating and financing activities significantly affect their returns such as (a) selling and purchasing of goods or services; (b) managing financial assets during their life (including upon default); (c) selecting, acquiring or disposing of assets; (d) researching and developing new products or processes; and (e) determining a funding structure or obtaining funding.
In such cases, the decisions affecting the returns may be linked to decisions such as establishing operating and capital decisions of the investee, including budgets; and appointing and remunerating an investee’s key management personnel or service providers and terminating their services or employment.
Relevant activities occur only when particular circumstances arise or events occur
There can also be investees for which relevant activities occur only when particular circumstances arise or events occur, as the direction of activities is predetermined until this date. In such cases, only the decisions about the investee’s activities when those circumstances or events occur can significantly affect its returns and thus be relevant activities.
As can be noted above, determination of activities that significantly affect the returns of an investee will be highly judgmental in some cases.
Key difference from IAS 27 (2008)
Unlike IFRS 10, IAS 27 (2008) does not include any guidance on the relevant activities of an investee for the purpose of assessing control.
Identify how decisions about the relevant activities are made
To determine control over the investee, IFRS 10 requires the investor to assess whether the investee is controlled by means of voting instruments or is controlled by means of other rights. Depending on the means of control, a different analysis is per-formed to assess which Investor has control over the Investee.
Assess whether the investor has power over the relevant activities
An investor has power over an investee when the investor has existing rights that give it the current ability to direct the activities that significantly affect the investee’s returns. As the definition of power is based on ability, power does not need to be exercised.
In assessing whether the rights held by an investor give it power, the following are considered:
Substantive rights
Only substantive rights held by the investor and oth-ers are considered. To be substantive, rights need to be exercisable when decisions about the relevant activities need to be made, and their holders need to have a practical ability to exercise the rights.
It may be noted that the ‘rights that need to be exercisable when decisions about the relevant activities need to be made’ is different from the current requirement under IAS 27 (2008) of ‘rights that are currently exercisable’. For instance, Entity A has an option to acquire a majority stake in Entity B and the option, which is deep in the money, is exercisable in 25 days’ time. Any shareholder of Entity B can call for a general meeting of the Company by giving a notice of 30 days. Thus in the given case, by the time the general meeting will be held, Entity A would have obtained the majority stake in Entity B and thereby the control (presuming the voting rights are considered relevant). This is different from IAS 27 (2008) where the control would be established only when the option becomes exercisable i.e., after 25 days. Thus, the revised control model may change the date of obtaining control over an investee.
Under IAS 27 (2008), the management’s intentions with respect to the exercise of potential voting rights are ignored in assessing control, because these intentions do not affect the existence of the ability to exercise power. Further, the exercise price of potential voting rights and the financial capability of the holder to exercise them also are ignored. As such, the intent of the parties is not considered when determining whether the rights are currently exercis-able. It seems that IFRS 10 would require the intent of the party who writes or purchases the potential voting rights would be taken into account when assessing whether the rights are substantive.
Protective rights are related to fundamental changes in the activities of an investee or apply only in exceptional circumstances. They cannot give their holders power or prevent others from having power.
IFRS 10 provides guidance on the rights of other parties, and in particular on protective rights. IAS 27 (2008) does not provide any such guidance and as such, guidance is mainly drawn from US GAAP.
Voting rights
An investor can have power over an investee when the investee’s relevant activities are directed through voting rights in the following situations:
? the investor holds the majority of the voting rights, and these rights are substantive; or
? the investor holds less than half of the voting rights but: (1) has an agreement with other shareholders; (2) holds rights arising from other contractual arrangements; (3) holds substan-tive potential voting rights; (4) holds rights sufficient to unilaterally direct the relevant activities of the investee (de facto power); or
(5) holds a combination of those.
The above guidance on voting rights under IFRS 10 is similar to that prescribed by IAS 27 (2008).
De facto control
The investor had de facto control over the investee, because its rights are sufficient to give it power as it has the practical ability to direct the relevant activities unilaterally.
Assessing whether an investor de facto has power over an investee is a two-step process:
? In the first step, the investor considers all facts and circumstances, including the size of its holding of voting rights relative to the size and dispersion of the holdings of other shareholders.
As a result, if the investor holds significantly more rights than any other shareholder and the other shareholdings are widely dispersed, then the investor may have sufficient information to conclude that it has power over the investee. In other cases, it may be clear that the investor does not control the investee. If the first step is not conclusive, then additional facts and circumstances are analysed in the second step.
? In the second step, the investor considers whether the other shareholders are passive in nature as demonstrated by voting patterns at previous shareholders’ meetings. Assessing the voting patterns at previous shareholders’ meeting may require consideration of the number of shareholders that typically come to the meeting to vote i.e., the usual quorum in shareholder’s meeting, and not how other shareholders vote i.e., whether they usually vote the same way as the investor.
If, after this second step, the conclusion is not clear, then the investor does not control the investee.
Assessing de facto control involves exercise of man-agement judgment. The areas involving higher level of management judgment includes:
? Determining whether the current shareholding in the Investee is sufficient;
? Determining whether the other shareholding is sufficiently dispersed; and
? Determining the exact date when the de facto control is obtained. It may be noted that the investor may not have any evidence of de facto control as at the date of acquiring investments. The evidence of de facto control may be obtained only after the initial stages of holding of an investment in the investee.
IAS 27 (2008) does not provide guidance on control whether it should be based on only the power to govern; or in addition to power to govern, the evaluation of control take into account the de facto circumstances. In practice, the reporting entities have an accounting policy choice whether to assess control based on power to govern or, based on de facto circumstances in addition to power to govern. IFRS 10 requires consideration of de facto circumstances as part of the control analysis, and as such eliminates the said accounting policy choice.
Rights other than voting
When holders of voting rights as a group do not have the ability to significantly affect the investee’s returns, the investor considers the purpose and design of the investee and the following three factors:
? evidence that the investor has the practical ability to direct the relevant activities unilater-ally;
? indications that the investor has a special relationship with the investee;
? whether the investor has a large exposure to variability in returns.
The first of these three factors is given the greatest weight in the analysis.
Assess whether the investor is exposed to variability in returns
The investor also should consider whether it is exposed, or has rights, to variability in returns from its involvement with the investee. Returns are defined broadly, and include distributions of economic benefits and changes in the value of the investment, as well as fees, remunerations, tax benefits, economies of scale, cost savings and other synergies.
Assess whether there a link between power and returns
Delegated power
In order to have control, an investor needs to have the ability to use its power over the investee to affect returns for the investor’s own benefit, i.e., there needs to be a link between power and returns.
An investor that has decision-making power over an investee determines whether it acts as an agent or as a principal when assessing whether it controls an investee. If the decision-maker is an agent, then the link between power and returns is absent and the decision maker’s delegated power is deemed to be held by its principal(s).
To determine whether it is an agent, the decision-maker considers:
(1) whether a single party holds substantive rights to remove the decision-maker without cause; if this the case, then the decision maker is an agent;
(2) whether its remuneration is on an arm’s-length terms; if this is not the case, then the decision-maker is a principal;
(3) the overall relationship between itself and other parties through a series of factors if neither (1) nor (2) is conclusive. These factors include:
? the scope of its decision-making authority over the investee;
? substantive rights held by other parties;
? the decision-maker’s remuneration (level of linkage with the investee’s performance); and
? its exposure to variability of returns because of other interests that it holds in the investee.
Different weightage is applied to each of the factors depending on particular facts and circumstances. The last two factors, i.e., remuneration and other interests held, are sometimes considered in aggregate in IFRS 10 and referred to as the decision-maker’s ‘economic interests’. The greater the magnitude of and variability associated with its economic interests, the more likely it is that the decision-maker is a principal.
Relationship with other parties
The investor determines whether other parties that have an interest in the investee are acting on behalf of the investor. When this is the case, the investor considers the decision-making rights held by these parties together with its own rights to assess whether it controls the investee.
Consolidation procedures
The consolidation procedures under IFRS 10 are similar to the consolidation procedures prescribed under IAS 27 (2008). This also includes accounting for loss of control over an investee.
Separate financial statements
The requirements of IAS 27 (2008) relating to separate financial statements have been retained in IAS 27 (2011).
Effective date and transitional requirements
