Whether the investor currently directs the activities

Whether the investor currently directs the activities Whether 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 to direct those activities. Whether the investor currently directs the activities

Having identified an investee’s relevant activities, the next step is to determine how those activities are directed. IFRS 10 breaks this down into the following two steps (although in practice these steps are normally combined with the identification of relevant activities):

  • understanding the decisions about relevant activities, Whether the investor currently directs the activities
  • identifying rights that confer ability to direct those decisions. Whether the investor currently directs the activities

Whether the investor currently directs the activities Whether the investor currently directs the activities

Decisions about relevant activities

Decisions about relevant activities include but are not limited to:

  • 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.

These decisions are broad-based and relate to high level direction of the investee. For traditional investees where the relevant activities comprise a wide range of financial and operating activities, direction is generally through these broad-based decisions. In other words there is usually no need to identify relevant activities at a specific or detailed level

In more complex situations where the relevant activities are identified at a more specific level direction might be through a more specific contractual right or process.

Ability to direct the decisions or rights

IFRS 10 envisages two types of rights that may confer ability to direct these decisions (i.e. power):

  • voting rights granted by equity instruments for example, ordinary shares,
  • contractual rights.

The Control model

Another relevant consideration is the level of involvement in decision making and access to information. Decision making rights granted to the investor might be solely protective, such as veto rights in respect of a sale of a portion of interest in the specified property or making significant amendments to the development plan for that property.

Alternatively, the arrangement might grant participating rights to the investor, such as participation in the development plan, work program, budgets and major transactions. Such activities could significantly affect the returns from the property and are often referred to as ‘relevant activities’. An investor that has the ability to vote when decisions over relevant activities are made is more likely to have acquired an interest in the property. The decision making usually aligns with the level of risk and rewards from an investment in the property and how involved the investor would like to be in driving the success of that property.

If an investor has only protective rights and does not participate in decision making over relevant activities, it does not automatically signal that the arrangement is financing. For example, in some royalty arrangements, the investor might be less involved in the decision making. Less involvement in decision making prompts further investigation as to what the investor has purchased.

The steps – identification of the investee’s relevant activities and how they are directed – determine the applicable category. The control assessment will typically be more straightforward when power is conferred through voting rights. In most cases involving traditional operating entities and governance structures, power is conferred by voting rights. For investees that would have been considered special purpose entities or structured entities however, power arises from more specific contractual rights. Whether the investor currently directs the activities

Direction of relevant activities

The chart below illustrates how the direction of relevant activities differs for traditional and structured entities: Whether the investor currently directs the activities

Whether the investor currently directs the activities

For many investees, a range of operating and financing activities significantly affect their returns. Examples of relevant activities, and decisions about them, include, but are not limited to: [IFRS 10 B11-B12]. Whether the investor currently directs the activities

  • Determining or changing operating and financing policies (which might include the items below) Whether the investor currently directs the activities
  • Selling and purchasing goods and services Whether the investor currently directs the activities
  • Managing financial assets during their life (and/or upon default) Whet her the investor currently directs the activities
  • Selecting, acquiring or disposing of assets Whether the investor currently directs the activities
  • Researching and developing new products or processes Whether the investor currently directs the activities
  • Determining a funding structure or obtaining funding Whether the investor currently directs the activities
  • Establishing operating and capital decisions of the investee, including budgets Whether the investor currently directs the activities
  • Appointing, remunerating or terminating the employment of an investee’s service providers or key management personnel.

In many cases, more than one activity will significantly affect an investee’s returns. Whether the investor currently directs the activities

Under IFRS 10, if two or more unrelated investors each have existing rights that give them the unilateral ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power over the investee. [IFRS 10 13].

In some situations, activities both before and after a particular set of circumstances arises or event occurs may be relevant activities. When two or more investors have the current ability to direct relevant activities and those activities occur at different times, the investors determine which investor is able to direct the activities that most significantly affect those returns consistently with the treatment of concurrent decision-making rights. The investors reconsider this assessment over time if relevant facts or circumstances change. [IFRS 10 B13].

When there is more than one activity that significantly affects an investee’s returns, and these activities are directed by different investors, it is important to determine which of the activities most significantly affect the investee’s returns. For example, one activity might be directed by voting rights, which are held by one investor, whereas the other activity is directed through a contract by a different investor. This is illustrated in IFRS 10. [IFRS 10 B13, Example 1].

Power

In order to assess power, only substantive rights that are NOT protective shall be considered. Whether the investor currently directs the activities

Substantive rights

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

This requires judgement and 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
  • For an example refer to IFRS 10 B24, example 3
Protective rights

‘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.’

Therefore an investor that only holds protective rights does not have power over an investee, neither can they prevent another party from having power over an investee.

Franchise agreements are generally considered to be protective rights.

Example – Protective rights and control

The board of directors of Pacific Plc have decided to dispose of a major subsidiary that accounts for a significant portion of their revenues and assets as they have decided to restructure the entity.

For this decision to be passed, it will require the approval of 75% voting rights held by shareholders.

One of the shareholders, Atlantic Plc holds a 15% stake in the group and has a “golden vote” (deciding vote). Atlantic Plc is unhappy with the proposed transaction.

Atlantic Plc can veto/block the decision (it has protective rights), it cannot make an alternate suggestion, therefore this is representative of Atlantic Plc having significant influence over Pacific Plc but not control.

. Whether the investor currently directs the activities Whether the investor currently directs the activities

Power – 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
Power without a majority of voting rights

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

Contractual arrangements with other vote holders

  • An investor can gain the right to exercise voting rights sufficient to give it power
  • Might ensure that the investor can direct other vote holders on how to vote to enable the investor to make decisions about relevant activities

Rights from other contractual arrangements

  • Voting rights in combination with other decision making rights, can give an investor the current ability to direct the relevant activities of the investee
  • Economic dependence of an investee on an investor does not automatically lead to the investor having power over the investee

The investor’s voting rights

The investor has the practical ability to direct the relevant activities unilaterally after considering all facts and circumstances such as

  • Relative size and dispersion of other vote holders
  • Potential voting rights held by other vote holders, other parties or the investor
  • Right from other contractual arrangements
  • Any additional facts or circumstances
Majority of voting rights but no power
  • Voting rights are not substantive
  • Relevant activities are not directed by vote
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
  • For an example refer to IFRS 10 B50, example 9

Whether the investor currently directs the activities Whether the investor currently directs the activities

Whether the investor currently directs the activities

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