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.

Something else -   The relevant activities of an investee

IFRS 10 Silos and deemed separate entities

Silos and deemed separate entities Silos and deemed separate entities Silos and deemed separate entities

The term ‘entity’ is widely used in IFRS and is usually well-understood. Entities are generally arrangements with separate legal personalities in accordance with law (such as companies, corporations, trusts, partnerships and unincorporated associations). However, entities are not defined and questions sometimes arise as to whether an arrangement is an ‘entity’. The example below illustrates one such situation:

Example Two investors – Shared plot of land

The case

The law in Country X provides a mechanism for two or more investors to own undivided shares in the same property. Two entities – Investor A and Investor B – acquire undivided shares in a plot of land of 60% and 40% and establish a co-ownership agreement setting out their intention to develop and operate a retail park on the site. The co-ownership agreement establishes the decision-making rights of each Investor, their respective obligations and the basis for allocation of profits from the venture.

What does this mean?

Based on these limited facts, judgement is required to decide whether the property, combined with the co-ownership agreement, is an ‘entity’. One view is that an entity is any circumscribed area of economic activity for which discrete financial information exists. Under this definition the arrangement described would be an entity. However, this definition is not authoritative.

If an entity exists, Investors A and B should apply IFRS 10 to assess which (if either) has control. If, for example, A has control it would consolidate the investee and recognise a 40% non-controlling interest. Alternatively, A and B might conclude they have joint control and that IFRS 11 applies. The contractual arrangements for this transaction have to be analysed to ascertain whether it is control by one party (60% voting right) or joint venture (contractual arrangements on decisions in relevant activities of the property).

If the arrangement is not an entity:

  • if it is jointly controlled it will be in the scope of IFRS 11, which applies to ‘joint arrangements’ whether or not structured through an entity

  • if it is not jointly controlled, each investor applies other applicable IFRSs. For example, Investor A might recognise its 60% share of the property as an asset, without recording any non-controlling interest. Investor B does the same with its 40% share.

IFRS 1o Control model – Identify the investee

Under the IFRS 10 Control model three steps need to be evaluated before the assessment of each step is coming to a conlusion. These steps are:

  1. Identify the investee,
  2. Understand the purpose and design of the investee,
  3. Identify the relevant activities of the investee and how decisions about these relevant activities are made.
Something else -   Investment funds

IFRS 10 Control model

The existence of control is made at the level of each investee. However, in some circumstances, the assessment is made for a portion of an entity (i.e. a silo). That is the case if, all the assets, liabilities and equity of that part of the investee are ring-fenced from the rest of the entity. The existence of silos is not confined to structured entities but is more likely to arise in such structuring.

Variable Interest Entity (VIE)

Now an example using US legal entities and presumptions that fit into the IFRS 10 Silos and the IFRS 10 Control Model.

Virtual SPE’s (divisions, departments, branches or pools odf assets subject to liabilities that are otherwise non-recourse to other assets of the broader entity) are not considered seperate entities for purposes of applying the VIE model. However, if the overarching legal entity is deemed a VIE, there are circumstances in which a virtual SPE or ‘silo’may be consolidated as if it were a stand-alone entity.

Accordingly, a presumption exists that “virtual entities” – for example, a particular pool of assets owned by a legal entity that isInternational Financial Reporting Standards 2 pledged to secure an obligation of the entity – are not separate entities that warrant a discrete consolidation analysis. Unless the specific conditions discussed below are present, the overarching legal entity serves as the unit of analysis under the IFRS 10 Control Model. IFRS 10 Silos and deemed separate entities

VIEs could be structured to separate the rights and obligations of different parties within an overarching legal entity, thereby allowing those parties to avoid consolidation. As a result, the guidance includes the notion of a “silo” in the VIE model. A silo can be thought of as a VIE within a VIE, in which a party holds a variable interest in only selected assets of the all-in legal entity.

A reporting entity with a variable interest in specified assets of a VIE shall treat a portion of the VIE as a separate VIE if the specified assets (and related credit enhancements, if any) are essentially the only source of payment for specified liabilities or specified other interests. (The portions of a VIE referred to in this paragraph are sometimes called silos.) That requirement does not apply unless the legal entity has been determined to be a VIE. If one reporting entity is required to consolidate a discrete portion of a VIE, other variable interest holders shall not consider that portion to be part of the larger VIE. IFRS 10 Silos and deemed separate entities

Under the IFRS 10 Control model it is emphasized that, to be considered a silo, the underlying arrangements must meet stringent criteria indicative of a stand-alone, de facto entity. IFRS 10 Silos and deemed separate entities

A specified asset (or group of assets) of a VIE and a related liability secured only by the specified asset or group shall not be treated as a separate VIE (as discussed in the preceding paragraph) if other parties have rights or obligations related to the specified asset or to residual cash flows from the specified asset. IFRS 10 Silos and deemed separate entities

A separate VIE is deemed to exist for accounting purposes only if essentially all of the assets, liabilities, and equity of the deemed VIE are separate from the overall VIE and specifically identifiable. In other words, essentially none of the returns of the assets of the deemed VIE can be used by the remaining VIE, and essentially none of the liabilities of the deemed VIE are payable from the assets of the remaining VIE. IFRS 10 Silos and deemed separate entities

Given this restrictive guidance, common opinion is that silos may exist in very limited circumstances, and may be given recognition only if the following conditions are met:

  • Specified assets, specified liabilities, and specified equity (if applicable) are clearly identifiable and separate from the overall entity IFRS 10 Silos and deemed separate entities
  • Essentially (1) none of the returns from the separate assets are available to holders of interests in the larger VIE and (2) the specified liabilities are not paid using assets of the larger VIE
  • The entity as a whole is a VIE IFRS 10 Silos and deemed separate entities

Also read: The IFRS 10 Control model

Something else -   Proportionate consolidation

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Something else -   Whether the investor currently directs the activities

IFRS 10 Silos and deemed separate entities

IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities – IFRS 10 Silos and deemed separate entities

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