Power – Existing rights that give the current ability to direct the relevant activities of an other company/investment. It is of importance in the assessment of control over an investee by an investor, leading to the question to consolidate the investee into the consolidated accounts of the investor.
“Power” is defined as the investor having such rights that (s)he can direct the activities that affect the investee’s returns. In the simplest cases, such power arises from the voting rights granted by shares. A parent company exerts power when it owns directly or through intermediate subsidiaries more than half of the voting power of the investee. Its vote allows it to direct the investee’s activities and appoint key members of its governing body.
- Even when power is exercised through shares, it may be difficult for third parties to identify controlling entities. Most globally operating corporations have a very diversified and international shareholder base; ownership can change rapidly over time (though arguably less for large blocks of capital); it is difficult to trace shares because they can be held through different group entities; subsidiaries whose shares are unlisted may not be subject to the requirements to disclose the identity of significant owners of their voting securities, contrary to what is generally requested from listed entities2.
- Power can also result from other means than voting shares, for instance contractual arrangements. This may allow for the control of entities without ownership of shares, for instance in the case of special purpose entities (such as securitisation/structured vehicles, which played an important role during the Great Financial Crisis of 2007–09).
- Conversely, an investor with more than half of the voting rights would not control the investee if its relevant activities are directed by other entities (for instance, if the direction is set by a government).
The application of the business accounting approach may require the assessment of a variety of factors3. In particular, rights that give an investor power may be evidenced by rights to appoint or remove members of the investee’s key management personnel, rights to direct the investee to enter into transactions, etc.
In addition, power may be exercised due to other contractual arrangements, or even if there is no contractual right (ie if there is evidence that the power is de facto exerted). Power can also be exercised by an investor having a special relationship which suggests that he has more than a passive interest in the entity.
This wide range of possibilities to define power relates to the fact that business accounting standards have been adapted in recent years to make more transparent the risks to which investors are exposed through their involvement with controlled entities and to better consolidate those exposures that used to be “off balance sheet” before.
Yet another complexity is that the rights have to be substantive to provide control, ie the holder must have the practical ability to exercise these rights. In contrast, protective rights only relate to fundamental changes to the activities of an investee or apply in exceptional circumstances. They are designed to protect the interests of their holder without giving that party power over the investee: as a result, an investor that holds only protective rights cannot have power [IFRS 10 11, IFRS 10 14]. IFRS recognises that determining whether rights are substantive requires judgement as several factors have to be considered for this purpose.
Key items to address:
- Whether rights are substantive or protective rights
- When an investor holds a majority of votes, focus on rights that could take power away
- When an investor holds a minority of votes, focus on rights that could give it power
- When the investee is not directed by votes, place greater focus on the purpose and design of the investee and other factors to determine whether power exists
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