6. IFRS 10 - Consolidated Financial Statements

7/28/2019 6. IFRS 10 - Consolidated Financial Statements

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The IASB recently published 3 new and 2 revised standards dealing with group issues and

off-balance sheet activities. We will cover the 3 new standards and the consequential

amendments reflected in the two revised standards. This module is not intended to discuss

these new standards in their entirety. Rather, it will focus on areas that will be most relevant

to you in understanding how the new provisions will impact their financial reporting.

We will provide a general background on the new standards. Then, we will discuss each new

standard in turn to cover what it tries to achieve, its key provisions, how it will affect IFRS

users and the relevant transition provisions.

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Presentation of consolidated financial statements

9 A parent, other than a parent described in paragraph 10, shall presentconsolidated financial statements in which it consolidates its investments in subsidiaries inaccordance with this Standard.

10 A parent need not present consolidated financial statements if and only

if:

(a) the parent is itself a wholly-owned subsidiary, or is a partially-ownedsubsidiary of another entity and its other owners, including those not otherwiseentitled to vote, have been informed about, and do not object to, the parent notpresenting consolidated financial statements;

(b) the parent's debt or equity instruments are not traded in a public market (adomestic or foreign stock exchange or an over-the-counter market, including localand regional markets);

(c) the parent did not file, nor is it in the process of filing, its financialstatements with a securities commission or other regulatory organisation for thepurpose of issuing any class of instruments in a public market; and

(d) the ultimate or any intermediate parent of the parent produces consolidatedfinancial statements available for public use that comply with International FinancialReporting Standards.

11 A parent that elects in accordance with paragraph 10 not to present consolidatedfinancial statements, and presents only separate financial statements, complies withparagraphs 3843.

Extracted from IAS 27, Consolidated and Separate Financial Statements. IASCFoundation.


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Power is the key issue not exercise of that power.

Included in the assessment will be for example any shares that have vested already

even though they have not actually been exercised. Intentions are irrelevant.

This consideration is only valid in deciding whether to consolidate. Actual current

holdings are used to determine shares of post acq profits for group and minority.

Benefits

dividends, interest, valuation gains or losses, service fees and other forms of

remuneration as well as synergies


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Control is presumed to exist when the parent owns, directly or indirectly through

subsidiaries, more than half of the voting power of an entity unless, in exceptional

circumstances, it can be clearly demonstrated that such ownership does not

constitute control.

- power over more than half of the voting rights by virtue of an agreement with

other investors;

- power to govern the financial and operating policies of the entity under a statute

or an agreement;

- power to appoint or remove the majority of the members of the board of directors

or equivalent governing body and control of the entity is by that board or body; or

- power to cast the majority of votes at meetings of the board of directors or

equivalent governing body and control of the entity is by that board or body.

The existence and effect of potential voting rights that are currently exercisable or

convertible, including potential voting rights

held by another entity, are considered when assessing whether an entity has the

power to govern the financial and operating policies of another entity. Potential

voting rights are not currently exercisable or convertible when, for example, they

cannot be exercised or converted until a future date or until the occurrence of a

future event.

In assessing whether potential voting rights contribute to control, the entity

examines all facts and circumstances (including the terms of exercise of the

potential voting rights and any other contractual arrangements whether considered


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In some cases, additional care needs to be taken to identify a control relationship

where there is no direct ownership interest, as is the case with many special purpose

entities. SIC 12 provides guidance and indicators of control of SPEs if control

exists, the SPE must be consolidated in accordance with IAS 27. More detailed

examples of the indicators on the slide are given in SIC 12 to demonstrate.

Issue addressed by SIC 12

1 An entity may be created to accomplish a narrow and well-defined

objective (eg to effect a lease, research and development activities or a

securitisation of financial assets). Such a special purpose entity ('SPE') may take the

form of a corporation, trust, partnership or unincorporated entity. SPEs often are

created with legal arrangements that impose strict and sometimes permanent limits

on the decision-making powers of their governing board, trustee or management

over the operations of the SPE. Frequently, these provisions specify that the policy

guiding the ongoing activities of the SPE cannot be modified, other than perhaps by

its creator or sponsor (ie they operate on so-called 'autopilot').

2 The sponsor (or entity on whose behalf the SPE was created)

frequently transfers assets to the SPE, obtains the right to use assets held by the SPE

or performs services for the SPE, while other parties ('capital providers') may

provide the funding to the SPE. An entity that engages in transactions with an SPE

(frequently the creator or sponsor) may in substance control the SPE.

3 A beneficial interest in an SPE may, for example, take the form of a

debt instrument, an equity instrument, a participation right, a residual interest or a

lease. Some beneficial interests may simply provide the holder with a fixed or stated

rate of return, while others give the holder rights or access to other future economic

benefits of the SPE's activities. In most cases, the creator or sponsor (or the entity

on whose behalf the SPE was created) retains a significant beneficial interest in the


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problem with first bullet - relies on identifying control relationship before disclosures are

required. In practice, what came out of the financial crisis was lots of special relationships

that did in fact represent control but which had not been consolidated as control had not

been identified

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The new standards were issued as a package and aim to provide consistent, principles-

based standards for the accounting of an entity's interest in other entities, commonly referred

to as investees. These new standards use common terminology and definitions (for example,

control and relevant activities) which can be applied for all types of investees.

These new standards also enhance convergence with US GAAP in key areas - for example,the option to use proportionate consolidation in accounting for an interest in what was

previously referred to as a jointly controlled entity has now been eliminated. This will increase

consistency of accounting for such type of interests.

More importantly, the publication of these standards is an important part of the IASB's

response to the financial crisis. It addresses concerns about the current consolidation

standards relating to whether the right things are being brought onto companies' statements

of financial position and whether financial statements sufficiently convey an entity's full

exposure to risks from its involvement with its investees, including unconsolidated entities.

Together with the enhanced disclosure requirements of IFRS 12, the IASB hopes that thenew standards will reduce structuring incentives, promote consistency in accounting and

improve transparency.

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Before we get into the details of each standard, let us look at the interaction of the

related standards. Understanding this relationship is key to identify the appropriate

IFRS to be applied in accounting for interests in an investee.

Assessment of control remains to be the key driver in determining how an investeewill be accounted for. IFRS 10's definition of control is applied. If the investor solely

controls the investee, then the consolidation provisions of IFRS 10 will apply.

In situations where there is joint control (a terminology defined in IFRS 11), the

underlying joint arrangement will be classified and accounted for in accordance with

the provisions of IFRS 11.

If the investor does not control the investee, it is outside the scope of IFRS 10 and

IFRS 11. It will be accounted for under IFRS 9 unless the investor has significant

influence over the investee, in which case, IAS 28 applies.

Whether the investment is accounted for under IFRS 10, IFRS 11 or IAS 28, the

disclosure requirements of IFRS 12 will apply.

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To appreciate what IFRS 10 is trying to achieve, it is helpful to understand the concerns around the existing

standards. Currently, there is a tension between the between requirements of IAS 27 and those of SIC 12 in

terms of identifying a parent/subsidiary relationship. IAS 27 focuses on the definition of control based on the

power to determine the operating and financial policies of an entity, for example through exercise of voting

rights. On the other hand, SIC 12 looks at special purpose entities in a way that is more focused on the

entity's exposure to the investee's risks and rewards. The different criteria used to identify parent/subsidiary

relationships for different types of entities has led to inconsistent application of the consolidation requirementin practice.

IFRS 10 addresses these concerns by providing a single consolidation model based on a new principles-

based definition of control. This model is applied to all types of investees, including special purpose entities.

IFRS 10 also provides additional guidance on how to apply the control model in borderline or less clear-cut

examples. This change is expected to better reflect the economic substance of the underlying relationship

between an investor and an investee in the consolidated financial statements.

With regard to disclosures, there are no current requirements to disclose any significant judgements and

assumptions made by an entity to determine control (other than the general requirement to disclose

significant management judgements under IAS 1.122) nor is there a requirement to disclose an entity's

exposure to risks related to its involvement in unconsolidated entities. Consequently, commentators feel thatthe financial statements do not faithfully convey all the risks that the entity is exposed to through its interests

in other entities.

IFRS 12 addresses these deficiencies and requires enhanced disclosures, which we will look at later in the

session.

These changes in the consolidation standard may give the impression that everything related to

consolidation is changed. This is not the case. The requirements and mechanics of consolidation (for

example, use of uniform accounting policies, elimination of group transactions, etc) and the accounting for

any non-controlling interests and changes in control remain the same. The previous IAS 27 requirements

have been transferred into IFRS 10.

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The first element is power over the investee. Power arises from existing rights and in

straightforward situations, it arises from owning more than 50% of the entity's voting rights

(when equity instruments clearly determine voting rights and powers to control). In other

cases, power may also arise from potential voting rights or by virtue of a contractual

agreement or a combination thereof.

Note however that not all rights automatically give rise to power. The underlying principle ofpower is that the existing right must provide the holder the current ability to direct the relevant

activities of the investee. IFRS 10, defines relevant activities as those activities that will

significantly affect the investee's returns. This is a narrower part of the entity's activities than

the IAS 27 focus on the more general financial and operating policies and so consequently

may lead to more entities being assessed as being controlled.

IFRS 10 also clarifies that when assessing power, only rights that are substantive are

considered. A right is considered substantive if the holder has the practical ability to exercise

that right (i.e., current ability to direct relevant activities and are usually currently exercisable,

although not always (refer to B10.24 for further guidance).

On the other hand, protective rights are those that are designed to protect the holder in

certain restricted circumstances but do not give power. For example, a power of veto that can

only be exercised to prevent fundamental changes being made to the activities of the

investee. The standard provides guidance on how to assess whether a right is substantive

which we will cover briefly later in the presentation.

The next element of control is the exposure or rights to variable returns. The term

'return' rather than 'benefits' is now used in the new definition to avoid the impression that

only positive results are considered. Returns relate to both the upside and downside of the

investee's results of operations.

Variability of return is also an important feature of this element. When assessing variability,

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In applying IFRS 10's control principle to determine the scope of consolidation, the investor

needs to consider:

the purpose and design of the investee

the relevant activities and how decisions are made relating to such activities and

the nature of its relationship with other parties.

The purpose and design of an investee could impact the assessment of what the relevant activities

are, how those activities are decided, who

can direct those activities, and who can receive returns from those activities (IFRS 10.B5). The

consideration of purpose and design may make it

clear that the entity is controlled by voting or potential voting rights (IFRS 10.B6).

IFRS 10 now includes helpful application guidance that considers these factors in certain

circumstances, mainly in situations where applying the control principle is expected to be

difficult, such as where:

a major investor has less than the majority of voting rights

potential voting rights are in issue, such as share options or convertible bonds are in issue

voting rights are not the dominant factor in deciding who controls the investees (such as is

common in special purpose vehicles)

the decision-making rights are delegated to another entity (the principal or agency

assessment) and

investor does not control an entity but has control over specified assets

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Let's consider an investor that owns less than 50% interest in an investee but that interest is

significantly more than any other vote holder or group of vote holders. Although the direction

of the relevant activities of the investee is determined by a majority vote, the significance of

the investor's shareholding may in substance represent power (this is referred to as 'de facto

control'). However, to support this conclusion, other factors should be considered

collectively, such as

the size of the voting rights compared to the size and dispersion of other vote holders

other facts and circumstances, such as previous voting patterns.

For example, an investor owns 45% of the voting rights, with the remaining 55% held by a

large number of widely dispersed individuals. Decisions made at shareholders meetings are

determined based on the majority of votes actually cast. Past experience shows that many

of the individual shareholders do not vote, and so historically the entity's 45% vote

represents the majority of votes cast and so under IFRS 10, this is likely to be considered a

controlling interest.

An investor with less than a majority of the voting rights may hold the largest block of voting rightswith the remaining voting rights widely-dispersed. The investor may have the power to unilaterally

direct the investee unless a sufficient number of the remaining dispersed investors act in concert to

oppose the influential investor. However, such concerted action may be hard to organise if it requires

the collective action of a large number of unrelated investors.

Note that this is concept known as de facto control is not new and a similar conclusion could

have been reached under IAS 27. However, IAS 27 was only implicit in this area and so

inconsistency arose in practice because it was common to conclude that de facto control

was not sufficient to support consolidation. However, IFRS 10 is explicit and so is more

likely to lead to a control conclusion.

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Now, let us look at potential voting rights. Under IFRS 10, potential voting rights are only considered in the

assessment of control if they are substantive, which will require judgement to determine. All facts and

circumstances need to be considered and there are some significant differences in this area compared to

IAS 27 that may affect control assessments; in particular:

under IAS 27, only potential voting rights that are currently exercisable at the reporting date are

considered. However, IFRS 10's requirement is that the rights should be exercisable in time to affect

decisions on relevant activities (i.e., including current voting rights and potential voting rights). It does notnecessarily require immediate exercisability. For example, an investor may have the right to acquire a

majority of an entity's voting rights under a forward contract. If the contract is to be settled in 25 days

time but the existing shareholders are unable to change the existing policies of the entity for at least 30

days (because, say, it takes 30 days to convene a special shareholders meeting), then the potential

voting right will be considered substantive in the assessment of control.

under IAS 27, the investor's intent and financial ability to exercise the rights are ignored in the control

assessment. IFRS 10 requires a more general consideration of the practical ability of the investor to

exercise the rights. This includes an assessment of the purpose and design of the rights, including an

investor's apparent expectations, motives and reasons for agreeing to the terms of the rights;

any barriers (economic or otherwise) that prevent the holder from exercising the rights, for example,

when exercise of the rights requires the agreement of more than one party, for example shareholder orregulator approval or where the entity holds share options that are so deeply-out-of-the-money that there

is no feasible scenario in which they would be exercised

however, being deeply-out-of-the money is not always a barrier because the entity that holds the rights

may benefit from exercising the options in other ways, for example the entity over which the options are

held may be a significant supplier or distributor and so synergistic benefits may be available.

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IFRS 10 also provides guidance on situations where voting rights are not the dominant factor in

deciding control, which is relevant to many special purpose vehicles or entities (or SPEs). Based on

the purpose and design of these entities, their relevant activities are usually directed by contractual

agreements and the voting rights often relate only to administrative tasks.

Currently, SIC 12 is applied and focuses on whether the investor has exposure to the significant risks

and rewards of the SPE to determine whether it needs to be consolidated. IFRS 10 changes the

framework in assessing control, bringing SPEs under the same control model we have alreadydiscussed. The standard provides indicators to be considered, including the purpose and design of

the investee, involvement and decisions made as part of the investee's design at inception, and

dependency on the investor for funding or provision of critical assets, technology or employees. Most

of these indicators are similar to those of SIC 12 and we won't go through each of them here.

However, an important thing to note is that IFRS 10 gives more weight to the investor's ability to

direct relevant activities, which are those that will have an effect on returns. In some cases, relevant

activities occur only when particular circumstances arise or events occur because the SPEs normal

activities are predetermined.

Exposure to the investee's risks and rewards is still considered as part of the analysis but it does not,

in itself, determine whether an investor has power over the investee. However, having a large

exposure to the variability of returns is a strong indicator that the investor may have power. This isbecause economically, significant exposure to variability gives the investor a big incentive to ensure

that they have the rights in place to allow them to control the SPE and protect themselves from

adverse risks.

With this change, it is difficult to predict whether IFRS 10 will lead to more or fewer special purpose

vehicles being consolidated and this area remains a matter of professional judgement.

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There is new guidance intended to help in situations where an entity has been delegated decision-

making rights over an investee. In such situations, IFRS 10 requires that the entity differentiate the

powers its exercises for its own benefit from those it exercises on behalf of others. In other words,

the entity needs to determine whether it is acting as a principal or an agent.

To determine whether an entity (the decision maker) is an agent, it considers its overall relationship

with the investee being managed and other parties involved in the investee. IFRS 10 provides a listof factors to be considered when making the assessment, as follows:

the scope of the its decision-making rights; such as the discretion it has when making decisions

rights held by other parties; such as substantive kick-out rights to remove the decision maker

the remuneration of the decision maker; whether is at a level commensurate to services provided

or whether there is variability associated with the results of the investee

and its exposure to variability of returns from any other interest that in holds in the investee

All of these factors needs to be evaluated and will require judgement. However, when a single party

holds substantive rights to remove the decision maker and can do so without cause, the decision

maker is then deemed to be an agent.

The effect of the determination is that an agent does not consolidate the investee because it

exercises its decision-making rights on behalf and for the benefit of others, which is not equivalent

to control. On the other hand, a principal will need to consolidate the investee, because it uses the

decision-making rights to it to obtain variable returns for its own benefit.

In practice, this guidance will apply to many entities who are delegated fiduciary powers, such as

fund managers who also hold direct interests in the funds managed on behalf of others. This new

guidance provides several examples that will result in greater consistency in the control

assessments for these types of entities.

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In general, control is assessed at the level of the investee, usually an entity. However, IFRS

10 now contains guidance relating to situations where the investor has control over specific

assets of an investee and so can consolidate a portion of an investee deemed to be a

separate entity, referred to as a silo. Consolidation of a silo will apply if and only if, all of the

assets, liabilities and equity of the silo are ring-fenced from the overall investee. This means

that none of the returns of the assets of the silo can be used by the remaining investee and

none of the liabilities of the silo can be paid from the assets of the remaining investee.

In this situation, the decision to consolidate the silo will require the investor to determine the

silo's relevant activities and how those activities are directed, in the same way the

assessment is made at the overall entity level already discussed.

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We just have time to highlight a couple of other requirements of IFRS 10.

IFRS 10 explicitly requires continuous assessment of control. The decision to consolidate

needs to be reassessed when facts and circumstances indicate changes to one or more of

the 3 control elements. This will often be triggered by the investor's own actions (for example

purchase or sale of investee shares) but IFRS 10 clarifies that an investor may gain or lose

power over an investee without any action from the investor. An example is where thedecision-making rights held by another party that previously prevented the investor from

controlling an investee expire.

Finally, IFRS 10 requires retrospective application of the new requirements but does provide

some transition provisions, specifically relating to the measurement of:

the assets, liabilities and non-controlling interest of a previously unconsolidated subsidiary

which will now be consolidated

the retained interest in a previously consolidated investee which will no longer be

consolidated.

IFRS 10 requires the amounts recognised under the new classification to be measured on

the date of initial application of the new standard, with any difference from the previous

carrying values to be recognised as an adjustment to equity.

Let us now hand over to Jojo to discuss IFRS 11 Joint Arrangements.

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Power with less than a majority of the voting rights

A reporting entity can have power over another entity by different means. A reporting entity

generally has that power when it holds the majority of the voting rights in another entity, in

the absence of factors to the contrary. A reporting entity can also have that power, even

though it holds less than a majority of the voting rights, because of agreements with other

vote holders, other contractual agreements, potential voting rights, its current voting rights

or a combination thereof. To assess whether a reporting entity has power over another entity

because of its voting rights, even though it holds less than a majority of the voting rights in

that entity, the reporting entity considers all available evidence. The evidence to be

considered includes the size of the reporting entitys holding of voting rights relative to the

size and dispersion of holdings of the other vote holders, voting patterns at previous

shareholders meetings, options and convertible instruments and other contractual

arrangements.

Potential voting rights

A reporting entity should consider potential voting rights (eg options and convertible

instruments) when assessing whether it has power over another entity. Therefore, the

assessment of whether a reporting entity has power includes not only a reporting entity's

voting rights in another entity, but also consideration of all the facts and circumstances

associated with potential voting rights instruments.

Principal-agency relationships

An agent is a party engaged to act on behalf of another party or parties (the principal) that

delegate some decision-making authority to the agent. When assessing its power over

another entity, the principal considers the decision-making authority that it has delegated to

agents. The agent does not automatically have power over another entity because decision-

making authority has been delegated to it. When assessing whether a party acts as an agent

or a rinci al the re ortin entit considers all facts and circumstances includin the

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6. IFRS 10 - Consolidated Financial Statements

Documents

Transcript of 6. IFRS 10 - Consolidated Financial Statements