Subsidiary as defined in IFRS 10

Subsidiary

A subsidiary is an entity that is controlled by another entity.

So a subsidiary is an investment by an entity (the parent) in an other entity (investee or subsidiary). But there are also other investments entities can invest in……..

In IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements and IFRS 12 Disclosures of interest in other entities all these types of investments are explained.

Here is a summary guidance relating to investments in subsidiaries in consolidated accounts and as a start a short summary of all of the types of investments to put into perspective investments in subsidiaries.

All of the types of investments by entities

The leading principle in classifying all of the types of investments is summarised in this illustration (the yellow boxes refer to classifications arrived at through the green decision boxes):

Subsidiary

IFRS 9 Equity instrument

The ownership of less than 20% creates an investment position carried at historic cost or fair value in the owning entity’s balance sheet.

These may comprise investments to receive income in addition to the regular income of the business or investments to secure trade ties with the invested companies.

Accounting: Historic cost with dividends recognised in profit or loss (especially equity instruments in privately held companies with no logical fair value comparable equivalent company) or fair value through profit or loss (especially equity instrument held for trading).

In addition, there is the possibility at initial recognition to designate equity instruments at fair value through other comprehensive income (without recycling).

The Board noted that presenting fair value gains and losses in profit or loss for some investments in equity instruments may not be indicative of the performance of the entity – in particular if these equity-instruments are held for non-contractual benefits rather than primarily for their increase in value.

However, the Board did not specify a principle that defined the equity investments to which the exception should apply. It had previously considered developing such a principle – including a distinction based on whether the equity-instruments represented a ‘strategic investment’ – but concluded that it would be difficult if at all possible, to develop a robust and clear principle. As a result, it made the fair value through other comprehensive income election generally available for all investments in equity-instruments in the scope of IFRS 9 that are not held for trading. However, the election is not available for:

  • investments in subsidiaries held by investment entities that are accounted for at fair value through profit or loss under IFRS 9; and
  • investments in associates and joint ventures held by venture capital organisations or mutual funds that are measured at fair value through profit or loss under IFRS 9.

IFRS 10 subsidiary

For an investor to control an investee, the investor must possess all of the following elements:

  • Power over the investee, which is described as having existing rights that give the current ability to direct the activities of the investee that significantly affect the investee’s returns (such activities are referred to as the ‘relevant activities’)
  • Exposure, or rights, to variable returns from its involvement with the investee
  • Ability to use its power over the investee to affect the amount of the investor’s returns (IFRS 10.7)

Subsidiary

This also referred to as single control over the investee.

– Identifying the investee and considering 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.

Control over specified assets and liabilities of an investee

An investor shall consider whether it treats a portion of an investee as a deemed separate entity and, if so, whether it controls the deemed separate entity. [IFRS 10, B76]

An investor shall treat a portion of an investee as deemed separate entity if and only if the following condition is satisfied:

  • Specified assets of the investee are the only source of payment for specified liabilities of, or specified other interest in, the investee. 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. [IFRS 10, B77]

In substance, all the assets, liabilities and equity of that deemed separate entity are ring-fenced from the overall investee. Such a deemed separate entity is often called a ‘silo’. [IFRS 10, B77]

Diagramatic representation of a ‘silo’ (deemed separate entity)

Subsidiary

The assets, liabilities and equity of each of the above ‘silo’s’ are ring fenced from the overall investee and each other

Something else -   Overview IFRS 10 Consolidated Financial Statements

Reference should be made to the control model.

– Link between power and returns

An investor with decision making rights therefore 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.

Reference is made to principal versus agent

Accounting: Consolidated at accounting policies defined by the parent, in parent company accounts: Equity method.

Joint control (use this link) and control are mutually exclusive. At least two parties must be there to have joint control, and this must be a contractually agreed sharing of control requiring unanimous consent.

IAS 28 Investment in associates

Entities: Investment in Joint ventures – Investment in Associates – Investment in Structured entities

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies.

Significant influence is usually (but not only!!!) acquired by purchasing more than 20% of voting power but less than 50%.

Accounting: Equity method at accounting policies defined by the parent

IFRS 11 Joint arrangements

Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. [IFRS 11.7]

In assessing whether an entity has joint control of an arrangement, an entity shall assess first whether all the parties, or a group of the parties, control the arrangement. When all the parties, or a group of the parties, considered collectively, are able to direct the activities that significantly affect the returns of the arrangement (ie the relevant activities), the parties control the arrangement collectively. (IFRS 11.B5–B8)

An entity shall assess whether it has joint control of the collectively controlled arrangement. Joint control exists only when decisions about the relevant activities require the unanimous consent of the parties that collectively control the arrangement. Assessing whether the arrangement is jointly controlled by all of its parties or by a group of the parties, or controlled by one of its parties alone, can require judgement.

Sometimes the decision-making process that is agreed upon by the parties in their contractual arrangement implicitly leads to joint control. In other circumstances, the contractual arrangement requires a minimum proportion of the voting rights to make decisions about the relevant activities, as such this will not lead top joint control in a frequent manner.

A joint arrangement can be classified as a

Classification of joint arrangements

Judgement will need to be exercised when making this classification (the yellow boxes refer to classifications arrived at through the green decision boxes, the blue boxes are evidencing documents used in answering the decision).

Subsidiary

In arriving at the classification, the rights and obligations of the parties to the arrangement must be assessed. The attributes of each type of joint arrangement are summarized below.

Subsidiary

Case – difference between joint venture and joint operation

iFone and Blakbery structure a joint arrangement in an incorporated entity, Cell. They each have a 50% ownership interest. The purpose of the arrangement is for Cell to manufacture parts for iFone and Blakbery’s own manufacturing processes. The arrangement ensures that the 2 parties operate the facility that produces the parts to their specifications.

The legal form of Cell through which the activities are conducted, initially suggest that the assets and liabilities held in Cell are the assets and liabilities of Cell. The contractual agreement does not specify that iFone and/or Blakbery have rights to the assets and obligations for the liabilities of Cell.

Therefore based on the legal form of Cell and the terms to the contractual arrangement, the arrangement is a joint venture.

However, consider the following aspects of the arrangement

  • The parties agreed to purchase all the output produced by Cell in the ratio of their ownership percentage. Cell may not sell its output to third parties, unless this is approved by iFone and Blakbery.
  • The arrangement is intended to operate at a break-even level. That is, the selling price is set by both parties and is designed to cover the costs of production and administrative expenses incurred by Cell.
Something else -   Uniform accounting policies for consolidation

From the above, the following facts and circumstances can be noted

  • The obligation of the parties to purchase all the output reflects the exclusive dependence of Cell upon the parties for the generation of cash flows therefore the parties have an obligation to fund the settlement of Cell’s liabilities.
  • The facts that the parties have rights to all the output means that the parties are consuming and therefore have rights to all the economic benefits of the assets of Cell.

The facts and circumstances indicate that the arrangement is a joint operation.

NORE – If the parties changed the contractual arrangement so that Cell was able to sell its output to third parties. Such a change in facts and circumstances would require re-assessment of the classification and such facts and circumstances would indicate that the arrangement is a joint venture.

Accounting for subsidiaries

Consolidation procedures

  1. Combine assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiary

  2. Offset (eliminate) the parent’s investment in each subsidiary with its portion of equity of the subsidiary

  3. Eliminate in full all intra-group transactions and balances

Uniform accounting policies

Parent and its subsidiaries must have and apply uniform accounting policies. If not, appropriate adjustments are made when preparing the consolidated financial statements to ensure conformity.

Measurement

Consolidation of a subsidiary begins from the date the investor gains control of an investee and ceases when the investor loses control of an investee

Potential voting rights

Consolidated financial statements are prepared solely on the basis of existing ownership interests. The consolidated financial statements do not reflect the possible exercise or conversion of potential voting rights and other derivatives unless, in substance, an interest is as a result of a transaction that currently gives the entity access to the returns associated with an ownership interest.

Reporting date

Parent and its subsidiaries must have the same reporting date. If not, the subsidiary, for consolidation purposes prepares additional financial information as of the same date as the financial statements of the parent unles

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.

Accounting treatment – loss of control

If the parent loses control of a subsidiary, the parent shall:

Significant judgements and estimates

IFRS 12 goes further than existing guidance3 in requiring disclosure about situations in which an entity applies significant judgement in assessing the nature of its interest in another entity. Specifically, the reporting entity shall disclose the judgements and assumptions made in determining that it has control, joint control, significant influence or an interest in another entity.

  • Details of significant judgements and assumptions made [IFRS 12.7 and 9]

    • significant judgements and assumptions made in determining that the investor:

    • examples may include, but shall not be limited to situations in which an investor:

      • – does not control another entity even though it holds more than half of the voting rights of the other entity

      • – controls another entity even though it holds less than half of the voting rights of the other entity

      • – is an agent or a principal.

  • Details when facts and circumstances change during the reporting period [IFRS 12.8 and 9B]

    • significant judgements and assumptions made when changes in facts and circumstances result in a change in the conclusion regarding control

    • when an entity becomes or ceases to be an investment entity and the reasons for the change

    • an entity that becomes an investment entity discloses the effect (in the period of the change), including:

    • the fair value of the subsidiaries no longer being consolidated (at the date of the change)

    • the gain or loss recognised in accordance with the loss of control requirements

    • where in the profit or loss the gain or loss is included (if not shown separately).

Something else -   Consolidation of foreign operations

Other required disclosures include the judgements and assumptions made when:

  • changes in facts and circumstances result in a change in the control assessment during the reporting period [IFRS 12.8]

  • a variance from the general control and non-control assumptions exists (for example, control exists despite holding less than half of the voting rights of the other entity) [IFRS 12.9]

  • concluding if an agent or principal relationship exists [IFRS 12.9]

  • determining that the entity is an investment entity [IFRS 12.9A].

  • Objectives [IFRS 12.10]

    • disclose information that enables users to understand/evaluate:

      • the composition of the group

      • interests of non-controlling interests in the group’s activities and cash flows

      • significant restrictions on ability of the reporting entity to access/use group assets and/or settle group liabilities

      • nature of and changes to risks associated with interest in consolidated structured entities

      • consequences of changes in ownership in a subsidiary that do not result in a loss of control

      • consequences of losing control of a subsidiary during the reporting period.

  • Non-coterminous period ends [IFRS 12.11]

  • Interest that non-controlling interests have in the group’s activities and cash flows [IFRS 12.12]

    • for material non-controlling interests, disclose:

      • the name of the subsidiary

      • the principal place of business and country of incorporation (if different)

      • the proportion of ownership interests held by non-controlling interests

      • the proportion of voting rights held by non-controlling interests (if different from the proportion of interests held)

      • the profit or loss allocated to non-controlling interests of the subsidiary during the reporting period

      • the accumulated non-controlling interests of the subsidiary at the end of the reporting period

      • summarised financial information about the subsidiary [IFRS 12.B10-B11].

  • Nature and extent of significant restrictions [IFRS 12.13]

    • significant restriction on its ability to access or use assets and settle the liabilities, such as:

      • – those that restrict its ability (or its subsidiary’s ability) to transfer cash or other assets to or from other entities within the group

      • – guarantees

      • – restrictions on dividends and other capital distributions being paid,

      • – restrictions on loans and advances made/repaid to/from other entities within the group

    • nature and extent to which protective rights of non-controlling interests can significantly restrict the entity’s ability to access or use the assets and settle the liabilities of the group

    • carrying amounts of the assets

  • Nature of, and changes to, risks associated with interest in consolidated structured entities [IFRS 12.14-17]

    • terms of any contractual arrangement(s) that could require the parent or its subsidiaries to provide financial support to a consolidated structured entity (including events or circumstances that could expose the reporting entity to a loss), such as:

      • liquidity arrangements or credit rating triggers (obligating it to purchase assets or provide financial support)

    • when the parent or any of its subsidiaries provided financial or other support to a consolidated structured entity (without having a contractual obligation to do so), disclose:

      • the type and amount of support provided

      • the reason for providing the support

    • relevant factors for consolidating (concluding control exists) a previously unconsolidated structured entity after providing financial or other support

    • current intentions to provide financial or other support to a consolidated structured entity, including intentions to assist the structured entity in obtaining financial support.

  • Consequences of changes in a parent’s ownership interest in a subsidiary, not resulting in a loss of control [IFRS 12.18]

    • schedule showing effects on the equity attributable to owners of the parent of any changes in its ownership interest that do not result in a loss of control.

  • Consequences of losing control of a subsidiary during the reporting period [IFRS 12.19]

    • gain or loss, if any, calculated in accordance with IFRS 10
    • the portion of that gain or loss attributable to measuring any investment retained in the former subsidiary at its fair value at the date when control is lost
    • the line item(s) in profit or loss in which the gain or loss is recognised, if not presented separately.

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Something else -   IFRS 10 Special control approach

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