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 significant judgement to determine which entities are deemed to be controlled and, therefore require consolidation by the parent company. Overview IFRS 10 Consolidated Financial Statements

Objective – The objective of IFRS 10 as set out in the standard is 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

The requirements: Overview IFRS 10 Consolidated Financial Statements

  • An entity (the parent) that controls one or more other entities (subsidiaries) presents consolidated financial statements;
  • The principle of “control” is defined, and control is the basis for consolidation;
  • Apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee;
  • Accounting for the preparation of consolidated financial statements; and
  • The concept of an investment entity is defined and the resulting exception to consolidating particular subsidiaries by an investment entity is ruled.

THE CONTROL MODEL An investee must CONTINUOUSLY assess whether it controls an investee

CONTROL only exists if ALL of these THREE elements are available to the investee:

POWER OVER THE INVESTEE

‘Power’ is defined as ‘existing rights that give the current ability to direct the relevant activities’

Therefore, when assessing whether an investor has power, there are two critical concepts, existing rights and relevant activities

EXPOSURE OR RIGHTS TO VARIABLE RETURNS

An investor is exposed or has rights to variable returns from its involvement with the investee. This refers to returns that are not fixed but rather vary depending on the performance of the investee

LINK BETWEEN POWER AND RETURNS

The investor must have the ability to use its power to affect the amount of the investor’s returns from its involvement with the investee

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Overview IFRS 10 Consolidated Financial Statements Overview IFRS 10 Consolidated Financial Statements Overview IFRS 10 Consolidated Financial Statements

STEPS TO CONSIDER WHEN DETERMINING WHETHER THERE IS CONTROL – See IFRS 10 Assessing control

  • Identifying the investee, consideration of its purpose and design
  • Identifying the relevant activities of the investee
  • Identifying how decisions about the relevant activities are made
  • Assessing whether the investor controls the investee

IDENTIFYING THE INVESTEE, CONSIDERATION OF ITS PURPOSE AND DESIGN

The term “investee” is not defined in IFRS 10, therefore the purpose and design of an investee shall be considered by the investor when assessing whether it has control of an investee

Investee controlled by means of equity instruments

  • An investor controls an investee when the investor holds majority of the voting rights and is able to exercise these rights to determine the investee’s operating and financing policies and no additional arrangements that alter this decision-making are present

Where voting rights are not the dominant factor in determining control, the investor would need to consider

The design of the investee in terms of

  • The risks the investee will be exposed to
  • The risk it will pass on to the parties involved with it, and
  • Whether the investor is exposed to some or all of that risk

By implication, if the investee’s risk exposure is high, it passes part of it on to the investor and the investor is exposed to some of that risk, it is likely that the investee has been set up under the power of the investor

IDENTIFYING THE RELEVANT ACTIVITIES OF THE INVESTEE

Relevant activities’ is a new concept which is integral to the control model as it assists in determining whether an investor has power over an investee

Definition of ‘relevant activities’ -these are activities of the investee that SIGNIFICANTLY affect the investee’s returns

Examples of relevant activities include, but are not limited to:

  • Selling and purchasing of goods or services
  • Managing financial assets during their life
  • Selecting, acquiring and disposing of assets
  • Researching and developing new products or processes
  • Determining a funding structure or obtaining funding

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

HOW DECISIONS ABOUT THE RELEVANT ACTIVITIES ARE MADE

The definition of “power” requires consideration of whether the investor has the current ability to direct the relevant activities, therefore it’s important to consider how decisions about the relevant activities are made

Decisions about relevant activities are (but are not only limited to these two examples)

  • Establishing operating and capital decisions of the investee, including budgets
  • Appointing and remunerating an investee’s key management personnel or service providers and terminating their services or employment

 

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

Overview IFRS 10 Consolidated Financial Statements

DETERMINE THE EXISTENCE OF CONTROL

SUBSTANTIVE RIGHTS

A right is substantive when the holder of that right has the practical ability to exercise that right

Factors to consider when making this decision include (but are not limited to) whether

  • There are barriers that prevent the holder from exercising its rights, for example laws and regulations
  • There is a practical mechanism to facilitate multiple parties to collectively exercise their rights
  • The party(s) holding the rights would benefit from the exercise of those rights
  • The rights are exercisable when decisions about relevant activities need to be made

PROTECTIVE RIGHTS

Is defined as ‘Rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate’

VOTING RIGHTS

Power with a majority of the voting rights

  • Relevant activities are directed by a vote
  • Majority of the governing body members are appointed by a vote

Majority of voting rights but no power

  • Voting rights are not substantive
  • Relevant activities are not directed by vote

Power without a majority of voting rights (“De facto power”)

Power without a majority of voting rights can be exercised by ANY of the following

  • Contractual arrangements with other vote holders
  • Rights from other contractual arrangements
  • The investor’s voting rights
  • The investor has the practical ability to direct the relevant activities unilaterally after considering all facts and circumstances

Potential voting rights

  • Only considered if they are substantive
  • Could arise from convertible instruments, options or forward contracts
  • The investor must consider the purpose and the design of the instrument

MORE THAN A PASSIVE INTEREST

Sometimes there will be indications that an investor has more than simply a passive interest. This may indicate that the investor has other related rights sufficient to give it power or provide evidence of existing power over an investee.

Examples that suggest that the investor has a more than passive interest

  • The investee’s key management personnel who direct relevant activities are current or previous employees of the investor
  • The investee’s operations are dependent on the investor
  • A significant portion of the investee’s activities either involve or are conducted on behalf of the investor
  • The investor’s exposure or rights to returns is disproportionally greater than its voting or other similar rights

An investor with decision making rights has to determine whether it is a principal or an agent

An agent is defined as ‘a party primarily engaged to act on behalf and for the benefit of another party or parties (the principal(s)) and therefore does not control the investee when it exercises its decision making authority’

Thus, sometimes a principal’s power may be held and exercisable by an agent, but on behalf of the principal. An investor that is an agent does not control an investee when it exercises decision making rights delegated to it.

Principal versus Agent

To determine whether a decision maker is an agent, it shall consider the overall relationship between itself, the investee being managed and other parties involved with the investee

ALL the following factors also need to be considered

  • Scope of decision making authority
  • Remuneration
  • Rights held by other parties
  • Decision maker’s returns from other interests in the investee

The evaluation of these factors is NOT required when a single party holds substantive rights to remove the decision maker without cause

Scope of decision making authority
  • The activities permitted by the decision making agreement and specified by law
  • The discretion available to the decision maker when making decisions
  • Purpose and the design of the investee
  • The risks the investee will be exposed to
  • The risk it will pass on to the parties involved with it and
  • The level of involvement the decision maker had in the design of the investee
Remuneration

The greater the magnitude of and variability associated with the decision maker’s remuneration in relation to the returns expected, the more likely that the decision maker is a principal

A decision maker cannot be an agent unless the following conditions are present

  • The remuneration is commensurate with the services provided
  • The remuneration includes only terms, conditions or amounts that are customarily present for similar services and level of skills negotiated on an arm’s length basis
Rights held by other parties

Substantive rights may affect the decision maker’s ability to direct relevant activities

  • When a single party holds removal rights, this is sufficient to conclude that the decision maker is an agent
  • Substantive right to restrict activities of the decision maker – apply same treatment as removal rights
Decision maker’s returns from other interests in the investee

A decision maker shall consider its exposure to variability of returns from its other interests in the investee in assessing whether it is an agent, in doing this the following are considered

  • The greater the magnitude of, and variability associated with, its economic interests, considering its remuneration and other interests in aggregate, the more likely that the decision maker is a principal

  • Whether its exposure to variability of returns is different from that of the other investors and, if so, whether this might influence its actions

Example – Principal versus agent

Pluto owns 68% of Jupiter and the remaining 32% is owned by Mars.

Pluto appoints Mars which is a management company to run its investment entity Jupiter. Mars is paid fixed and performance fees in relation to the services provided. This, in combination with the return on investment creates exposure to variability in return.

Pluto has the right to remove Mars as the management company of Jupiter if it so wishes.

Pluto has power as Pluto has substantive rights to remove Mars if it so wishes therefore Mars is an agent and not a principal therefore Mars would not need to consolidate Jupiter.

RELATIONSHIP WITH OTHER PARTIES (“DE FACTO AGENTS”)

When assessing control, an investor needs to consider the nature of its relationship with other parties. In doing so the investor must consider whether those other parties are acting on the investor’s behalf (i.e. they are ‘de facto agents’). Such a relationship need not have a contractual arrangement.

Examples of other parties that may act as “de facto agents” for the investor:

  • The investor’s related parties.
  • A party whose interest in the investee is through a loan from the investor.
  • A party that has agreed not to sell,transfer or encumber its interests in the investee without prior approval of the investor.
  • A party that cannot finance its operations without the investor’s subordinated financial support.
  • An investee for which the majority of its governing body or key management personnel are the same as that of the investor.
  • A party that has close business relationship with the investor.

INVESTMENT ENTITIES

An investment entity is defined as ‘an entity that

  • Obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services
  • Commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both
  • Measures and evaluates the performance of substantially all of its investments on a fair value basis’

An investment entity shall NOT consolidate its subsidiaries but rather measure an investment in a subsidiary at fair value through profit or loss in accordance with IFRS 9.

Typical characteristics of an investment entity:

  • It has more than one investment;
  • It has more than one investor;
  • The investors are not related parties of the entity; and
  • It has ownership interests in the form of equity or similar interests.

Consolidation specifics and exceptions

Investment entities shall not consolidate its subsidiaries but rather measure an investment in a subsidiary at fair value through profit or loss in accordance with IFRS 9 UNLESS:

  • If an investment entity has a subsidiary that provides services that relate to the investment entity’s investment activities, it shall consolidate that subsidiary. Examples of investment related services are
    • Investment advisory services
    • Investment management
    • Investment support
  • A parent of an investment entity shall consolidate all its subsidiaries, including the investment entity and any entities controlled through that investment entity, unless the parent itself is an investment entity.

CONSOLIDATION ACCOUNTING REQUIREMENTS

  • Consolidation–Combine assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiary. Offset (eliminate) the parent’s investment in each subsidiary with its portion of equity of the subsidiary. Eliminate in full all intra-group transactions and balances.
  • Parent and its subsidiaries must have and apply uniform accounting policies, if not, alignment adjustments must be quantified and posted
  • Consolidation begins from the date the investor gains control of an investee and ceases when the investor loses control of an investee
  • Reporting dates cannot vary by more than 3 months

DISCLOSURE AND ACCOUNTING TREATMENT OF NON-CONTROLLING INTERESTS

A parent must present non-controlling interests in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. Changes in a parent’s ownership interest in a subsidiary that do not result in the parent losing control of the subsidiary are equity transactions.

Overview IFRS 10 Consolidated Financial Statements

ACCOUNTING TREATMENT – LOSS OF CONTROL

If the parent loses control of a subsidiary, the parent will

  • Derecognise the assets and liabilities of the former subsidiary
  • Recognise any investment retained in the former subsidiary at its fair value when control is lost and subsequently accounts for it and for any amounts owed by or to the former subsidiary in accordance with relevant IFRSs
  • Recognise the gain or loss associated with the loss of control in profit or loss

See also: Consolidated financial statements

Overview IFRS 10 Consolidated Financial Statements

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