Accounting by investment entities

Accounting by investment entities

is about the accounting requirements in IFRS 10 for investment entities that are limited to an exception from consolidation of investments in certain subsidiaries. The exception also impacts the separate financial statements of an investment entity (if these are prepared). The table summarises the key requirements:

Requirements Details
Accounting for subsidiaries held as investments

 

  • subsidiaries held as investments are measured at fair value through profit or loss in accordance with IFRS 9 instead of being consolidated [IFRS 10 31]. This accounting is mandatory not optional. Voluntary consolidated financial statements that state compliance with IFRS are not permitted
  • IFRS 3 does not apply to the obtaining of control over an exempt subsidiary
  • the consolidation exception also applies to controlling interests in another investment entity.
Accounting for service subsidiaries
  • an investment entity is still required to consolidate subsidiaries that are not themselves investment entities and whose main purpose and activities are providing services that relate to its investment activities [IFRS 10 32]
  • IFRS 3 applies on obtaining control over a service subsidiary.
Accounting in separate financial statements
  • an investment entity’s fair value accounting for its controlled investees also applies in its separate financial statements [IAS 27 11A]
  • if the consolidation exception applies to all an investment entity’s subsidiaries throughout the current and all comparative periods (ie it has no services subsidiaries) its separate financial statements are its only financial statements [IAS 27 8A].

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IFRS 10 Special control approach

IFRS 10 Special control approach

– determines which entities are consolidated in a parent’s financial statements and therefore affects a group’s reported results, cash flows and financial position – and the activities that are ‘on’ and ‘off’ the group’s balance sheet. Under IFRS, this control assessment is accounted for in accordance with IFRS 10 ‘Consolidated financial statements’.

Some of the challenges of applying the IFRS 10 Special control approach include:

  • identifying the investee’s returns, which in turn involves identifying its assets and liabilities. This may appear straightforward but complications arise when the legal ownership of assets diverges from the accounting depiction (for example, in financial asset transfers that ‘fail’ de-recognition, and in finance leases). In general, the assessment of the investee’s assets and returns should be consistent with the accounting depiction in accordance with IFRS
  • it may not always be clear whether contracts and other arrangements between an investor and an investee
    • create rights or exposure to a variable return from the investee’s performance for the investor; or
    • transfer risk or variability from the investor to the investee IFRS 10 Special control approach
  • the relevant activities of an SPE may not be obvious, especially when its activities have been narrowly specified in its purpose and design IFRS 10 Special control approach
  • the rights to direct those activities might also be difficult to identify, because for example, they arise only in particular circumstances or from contracts that are outside the legal boundary of the SPE (but closely related to its activities).

IFRS 10 Special control approach sets out requirements for how to apply the control principle in less straight forward circumstances, which are detailed below:  IFRS 10 Special control approach

  • when voting rights or similar rights give an investor power, including situations where the investor holds less than a majority of voting rights and in circumstances involving potential voting rights
  • when an investee is designed so that voting rights are not the dominant factor in deciding who controls the investee, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements IFRS 10 Special control approach
  • involving agency relationships IFRS 10 Special control approach
  • when the investor has control only over specified assets of an investee
  • franchises. IFRS 10 Special control approach

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Best Read – IFRS 10 Silos and deemed separate entities

IFRS 10 Silos and deemed separate entities

generally require the control assessment to be made at the level of each investee entity. However, in some circumstances the assessment is made for a portion of an entity (a deemed separate entity). This is the case if, and only if, all the assets, liabilities and equity of that part of the investee entity are ring-fenced from the overall investee (often described as a ‘silo’) [IFRS 10 B76 – B79]. IFRS 10 Silos and deemed separate entities

Silos most often exist within special purpose vehicles in the financial services and real estate sectors (for example, ‘multi-seller conduits’ and captive insurance entities). However, the conditions for a silo to be deemed a separate entity for IFRS 10 purposes are strict. The example below illustrates the silo concept: IFRS 10 Silos and deemed separate entities

Example Bank – SPV – 2 Corporate clients

The case

Bank A establishes and administers a special purpose vehicle that enables two corporate clients – Companies A and B – to sell trade receivables in exchange for cash and rights to deferred consideration. The vehicle issues loan notes to outside investors to fund the purchases. Each company remains responsible for managing collection of its own transferred receivables. Bank A provides credit enhancements in exchange for a fee. The terms of the loan notes and contractual document establish how cash collected from each pool of receivables is allocated to meet payments of the loan notes. Cash collected in excess of the specified allocation is paid to the originators.

What does this mean?

A portion of an entity is treated as a silo if, and only if, the following conditions are met:

  • specified assets of the investee (and related credit enhancements) are the only source of payment for specified liabilities
  • parties other than those with the specified liability do not have rights or obligations related to the specified assets or to residual cash flows from those assets
  • in substance, none of the returns from the specified assets can be used by the remaining investee and none of the liabilities of the deemed separate entity are payable from the assets of the remaining investee.

However, in a real life case, further analysis will be required to determine whether the allocation provisions create a situation in which each pool of assets is substantially viewed as the only source of payment for specified liabilities.

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Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial StatementsShort – To establish principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities Overview IFRS 10 Consolidated Financial Statements

Longer – IFRS 10 replaces the part of IAS 27 Consolidated and Separate Financial Statements that addresses accounting for subsidiaries on consolidation. What remains in IAS 27 after the implementation of IFRS 10 is the accounting treatment for subsidiaries, jointly controlled entities and associates in their separate financial statements.Contingent consideration Contingent consideration Contingent consideration Contingent consideration Contingent consideration

The aim of IFRS 10 is to establish a single control model that is applied to all entities including special purpose entities. The changes require those dealing with the implementation of IFRS 10 to exercise Read more

What are Consolidated Financial Statements in IFRS 10

What are Consolidated Financial Statements in IFRS 10 and the relations with IFRS 11 IFRS 12 IAS 27 IAS 28 and disclosures for consolidation and investments.

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IAS 27 Separate Financial Statements, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 28 Investments in Associates and Joint Ventures and IFRS 12 Disclosures of Interest in Other Entities are all relating to or are otherwise intertwined with IFRS Types of Investments in (Consolidated) Financial Statements.

To better understand these 5 IFRS Standards and their interactions, co-relations, and maybe contradictions, here are all the important things summarised.

What are Consolidated Financial Statements in IFRS 10 What are Consolidated Financial Statements in IFRS 10 What are Consolidated Financial Statements in IFRS Read more

Combined financial statements

Combined financial statements: The combination of two or more legal entities or businesses that may or may not be part of the same group, but do not by themselves meet the definition of a group under IFRS 10 Consolidated Financial Statements – i.e. a parent and all of its subsidiaries. At a simplistic level, preparing combined financial statements involves adding together two or more legal entities and eliminating any inter-company transactions – e.g. intercompany profits, revenue and expenses, receivables and payables and equity (e.g. unrealised gains and losses).

Introduction to Investment entities

Introduction to Investment entities is about information provision through financial statements to knowledgeable investors. For many years, preparers and investors in the investment entity industry felt that consolidating the financial statements of an investment entity and its investees does not provide the most useful information. Consolidation made it more difficult for investors to understand what they are most interested in – the value of the entity’s investments.

IFRS 10 provides an exception to consolidating particular subsidiaries for investment entities. The exception requires an investment entity to measure those subsidiaries Read more

Whether the investor currently directs the activities

Whether the investor currently directs the activitiesWhether the investor currently directs the activities – In assessing control, an investor considers both substantive rights that it holds and substantive rights held by others. To be ‘substantive’, rights need to be exercisable when decisions about the relevant activities are required to be made, and the holder needs to have a practical ability to exercise those rights. Whether the investor currently directs the activities

Power is assessed with reference to the investee’s relevant activities, which are the activities that most significantly affect the returns of the investee. As part of its analysis, the investor considers the purpose and design of the investee, how decisions about the activities of the investee are made, and who has the current ability … Read more

The relevant activities of an investee

The relevant activities of an investee – Don’t get fooled, relevant activities for financial reporting and consolidation purposes does not mean that the activities of an investee are the same as the activities of other entities (parent entity and subsidiary entities) consolidated into that one group. No…….. it is about whether the activities significantly affect the investee’s returns. In other words can the parent entity earn from the relevant activities.

Let that be clear!!

IFRS 10 introduces the concept of ‘relevant activities’. This is a critical part of the model. This concept clarifies which aspects of an investee’s activities must be under the direction of an investor for that investor to have control for consolidation purposes.The relevant activities of an investee

Examples of activities that, … Read more

Securitisation in 1 Best Complete Reading

Securitisation entails pooling the cash flows and selling them to investors via a special purpose vehicle, turning ‘illiquid’ assets into a more ‘liquid’ asset.