Ability to use power to affect the returns

“The ability to use power to affect the returns” means that an investor controls an investee not only if (s)he has power and exposure to its returns but also the ability to use its power to affect these returns. If not, an investor which has decision-making rights with regard to an investee but which cannot influence the investee’s returns will be considered an “agent” – and not the “principal” that is in control of the investee. [IFRS 10 17 Link between power and returns]

Summarised: Ability to use power to affect the returns

  • the definition reflects the fact that IFRS 10 applies to special purpose or structured entities as well as more conventional entities
  • in more complex control assessments IFRS 10 requires identification of the activities that most affect the investee’s returns (the ‘relevant activities’), and how they are directed, at a more granular level Ability to use power to affect the returns
  • in simpler assessments involving conventional entities it is sufficient to consider activities at the financial and policy level.

Key to IFRS 10 Consolidated financial statements, IFRS 11 Joint arrangements, IFRS 12 Disclosure of interest in other entities and IAS 28 Investments in Associates and Joint ventures are the concepts of power, returns and a linkage between power and returns.  In summary, these concepts are:

Power – the ability to exercise existing rights to direct the relevant activities of an entity. Ability to use power to affect the returns

Returns – an exposure or rights to, a variable return from an involvement with an entity (the investee) as a result of the performance of that entity.

Linkage – For an investor to control an entity, the investor needs power and returns as well as the ability to use the power to affect the returns, in effect the linkage between the power and the returns. Ability to use power to affect the returns

Ability to use power to affect the returns

This link between power and returns clearly exists in a normal parent-subsidiary relationship based on majority share ownership. Accordingly, in such cases a detailed analysis is not needed. However, this third element of control is important when an investor holds decision-making rights as a result of a management contract or similar arrangement – such as a fund or asset manager.

If an investor has some or all of its decision-making rights in the capacity of agent, those rights do not count towards the assessment of whether it controls the investee. Conversely, if the investor has delegated some or all of its decision-making rights to an agent, those rights are treated as the investor’s rights for IFRS 10 purposes. This is illustrated as follows:

Ability to use power to affect the returns

IFRS 10 also includes the concept of a ‘de facto’ agent, ie an entity that acts on the investor’s behalf even though there is no contractual arrangement that obliges it to do so.

Examples of the types of entity or other party that might act as a de facto agent include:

  • the investor’s related parties Ability to use power to affect the returns
  • a party that received its interest in the investee as a contribution or loan from the investor Ability to use power to affect the returns
  • a party that has agreed not to sell, transfer or encumber its interests in the investee without the investor’s prior approval
  • a party that cannot finance its operations without subordinated financial support from the investor Ability to use power to affect the returns
  • an investee for which the majority of the members of its governing body or for which its key management personnel are the same as the investor’s
  • a party that has a close business relationship with the investor such as the relationship between a professional service provider and one of its significant clients [IFRS 10 B75].

The guidance on de facto agents is not intended to imply that parties listed above would always act for the investor. The assessment requires judgement, including careful consideration of the nature of the relationship and the way that the parties interact with each other. To some extent this guidance appears to be designed as an ‘anti-abuse’ provision, intended to ensure that control cannot be disguised by the informal delegation of power to other parties. Ability to use power to affect the returns

Key situations to watch out for include partially owned entities where management and executive functions are undertaken by an investor or alternatively structured entities where management decision making rights are exercised by an entity that is only partially invested in the structured entity (i.e., mining joint ventures and managed investment schemes).  Of course, for many companies (particularly wholly-owned corporate groups) this standard will not affect their consolidation processes.


Ability to use power to affect the returns

Ability to use power to affect the returns Ability to use power to affect the returns Ability to use power to affect the returns Key situations to watch out for include partially owned entities where management

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