IFRS 10 - Consolidated Financial Statement (detailed review)
This standard prescribes the principle of control and the guidelines which are used by the entity for the identification and establishment of control. It also deals with the preparation and presentation of consolidated financial statements if the reporting entity has control over one or more other entities
The requirements of this standard are applied by the parent for the preparation and presentation of consolidated financial statements in respect of one or more other entities it controls except for the following:
a) The parent is not required to prepare the consolidated financial statements in respect of one or more other entities it controls if it satisfy the all the below mentioned conditions simultaneously:
- The reporting entity itself is a wholly or a partially owned subsidiary of another entity and its owners do not have any objection for not preparing the consolidated financial statements
- The equity or debt instruments of the reporting entity are not traded in any public, local and regional market
- The reporting entity is not in the process of issuing any class of instruments for trading in a public market
- The ultimate or any intermediate parent of the reporting entity prepares consolidated financial statements for public use.
b) If the parent is an investment entity, which is not required to prepare consolidated financial statements in respect of one or more other entities it controls, and measures such investments at fair value through profit or loss as per the requirements of this standard
c) If the entity subject to control is a post employment or other long term employee benefit plan which is covered under IAS 19
The entity is deemed to have control over investee if entity has the following aspects with the investee:
a) Right or exposure to the variable returns from investee
b) Power over investee
c) Current ability to use the power over investee to affect those returns from the investee
- The entity should also consider all the related facts and circumstances in the assessment of control and the entity is required to reassess the aspects establishing control if circumstances indicate that there is change in one or more of the three elements of control
- If the entity is required to act together with one or more other parties, to control an investee and no investor can direct the relevant activities of investee on individual basis, such circumstances will give rise to joint control therefore, in this case each investor will account for its interest in the investee in accordance with IFRS11
- In certain circumstances, when two or more entities have existing rights which give them the independent ability to direct, the different relevant activities of the investee, then in such a situation, the entity having the current ability to direct the relevant activities that most substantially affect the returns from investee, will be deemed to have control over investee.
In determination of control the entity should also consider the following:
1. Purpose and Structure of the Entity
The entity should also consider the purpose and structure of the investee, such as how the decision about the relevant activities are taken and whether the voting rights underlying equity instruments in the investee are used to exercise control over the investee, because in some cases the voting rights underlying equity instruments are only used to take decision about administrative activities and the controlling rights are subject to the contractual arrangements with the other parties.
The variable returns from investee includes fluctuating returns from investee, these may be positive or negative depending upon the performance of the investee. These include dividend income or management fee for the managerial services provided to investee based on the performance of investee.
Power over investee is one of the essential elements of control. The entity is deemed to have power over investee, when it is able to direct the relevant activities of the investee which includes the decision about the operating, financial and accounting policies of investee such as:
- Nature of goods or services
- Decision regarding capital investment
- Research and development activities
- Decision regarding capital structure
- Appointment of key management personnel of the investee
4. Ability to use the Power
In order to control an investee, the investor must have the present ability to exercise the power over investee. The power always comes with certain rights. The rights which individually or in combination give the investor power over investee are:
- Normally, it is when an investor owns more than 50% voting rights of the investee, but there are circumstances, when investor owns less than 50% voting rights of the investee but investor is still able to exercise the power over investee, such rights include:
- When investor has the right to appoint, remove or reassign the key management personnel of the investee who are able to direct the relevant activities of the investee
- When investor has the right to appoint, remove or reassign another entity which is able to direct the relevant activities of the investee
- When investor has the rights to direct the investee to enter into or veto any changes to transactions for the benefit of the investor
- When investor has other rights in the contract which gives investor the ability to direct the relevant activities of the investee
- When investor has majority of the voting rights in investee while remaining voting rights are held by large number of individuals and each is having holding less than the investor’s aggregate holding
- Sometimes, an investor has a passive interest in the investee which may also indicate that investor has present ability to use the power over investee. It includes:
a) The key management personnel of the investee those direct its relevant activities are current or former employees of the investor.
b) The operations of investee are dependent upon the investor
c) The investor has financed the major part of the operations of investee
d) The significant portion of investee’s obligations is guaranteed by the investor
e) The investee is dependent upon the investor in respect of its core services such as technology, supplies or raw materials.
f) The investee depends on the investor for key management personnel, such as when the investor’s personnel have specialized knowledge of the investee’s operations.
- The rights which are used to determine the investor’s ability to exercise the power over investee must be substantive rights (the rights which give rise to control, as mentioned above)
- The entity acting as an agent to make decisions for another entity on behalf of the investor (principal) does not assume to have control over the investee, instead investor will be treated as having those delegated decision making rights directly and thus controls the investee
- The rights which are used to determine the investor’s ability to exercise the power over investee should not be protective rights (which are used only to safe guard the interest of the parties holding such rights and do not give rise to control, these are exercisable in limited circumstances such as bank covenants)
- In determination of investor’s ability to exercise the power over investee, the entity should also consider the investor’s contractual relationship with the other parties that have voting rights in the same investee
- If the entity owns share options, share warrants, debt instruments or any other equity instruments which are convertible into ordinary shares, and have the potential to entitle the entity with additional voting rights in the investee, if exercised or converted. Therefore, in determination of entity’s ability to exercise the power over investee, the entity should consider not only the existing voting rights but also such potential voting rights, if these are currently exercisable or can be converted any time and such rights are in the money (at favorable terms)
The entity which is parent is required to prepare consolidated financial statements in respect of all the entities it controls either directly or indirectly, for this purpose entity will consider the following:
- The consolidation of investee starts right from the date when control is obtained
- The parent will consolidate the investee on the using purchased method of accounting i.e. 100% addition of assets, liabilities, incomes and expenses of investee with like items of the parent, on the basis of single economic entity concept i.e. parent and its investee under control will be treated as one entity for the purpose of consolidation
- The investment held by the parent in investee and investee’s equity at the date of acquisition will be eliminated and these will be used to calculate goodwill
- The assets and liabilities of the investee will be consolidated at fair value as per IFRS 3 and any resulting adjustment will be made for the additional depreciation or amortization based on the fair value of investee’s depreciable assets at the date of acquisition
- The consolidation of investor and its investee should be performed using the same accounting policies and, if the accounting policies of the investor are different from those of the investee in respect of like transactions or events, then adjustment will be made to bring in line the accounting policies of the investee as to the accounting policies of investor before consolidation.
- If the reporting date of investor is different from those of the investee, such situation will be accounted for as follows:
a) If the difference between the reporting date of investor and that of the investee is less than three months, then adjustments will be made for the effects of material events or transactions which has taken place between the reporting date of the investor and investee’s financial statements
b) If the difference between the reporting date of investor and that of the investee is more than three months, then the investee is required to prepare, additional financial statements to the same reporting date as the financial statements of the parent for the purpose of consolidation.
- The unrealized profit relating to transactions between the parent and investee will be eliminated on consolidation
- Similarly, intra-group (between the parent and investee) receivable and payable balances will be eliminated on consolidation
- The non-controlling interest will be presented separately in the equity section of the consolidated statement of financial position from the equity of the owners of the parent
Loss of Control
If the parent disposes off its interest in investee which results in loss of control, it will be accounted for as follows, the parent will:
- De-recognize the assets, liabilities, goodwill and non-controlling interest relating to the investee from the consolidated financial statements, from the date it ceases to have control over investee
- Recognize the resulting gain on loss on disposal of interest in investee in the statement of profit or loss
- Recognize any interest retained in investee after the disposal, as per the requirements of IFRS 9
- Reclassify to statement of profit or loss, any items related to the investee which are recognized in the other comprehensive income.
Changes in the Ownership Interest
If there is change in the ownership interest between the investor and non-controlling interest in investee, such change in ownership interest will be accounted for as transaction between owners and any resulting difference will be directly recognized in equity.
A parent will be treated as an investment entity in the following conditions:
- It obtains funds for providing investment management services to one or more investors
- Its business objective is to invest funds only for the purpose of returns from capital appreciation, investment income or both for the investors
- It measures and evaluates the performance of all its investments on a fair value basis.
Additionally the investment entity should have the following characteristics:
- it has more than one investment
- it has more than one investor
- It has investors that are not related parties of the entity
- it has ownership interests in the form of equity or similar interests
Accounting for Investment Entity
A parent which is investment entity is not required to consolidate its subsidiaries or apply IFRS 3, when it obtains control of another entity. Instead, such parent (investment entity) will measure its investment in a subsidiary at fair value through profit or loss in accordance with IFRS 9
- However, a parent of an investment entity will consolidate all entities that it controls, including those controlled through an investment entity unless the parent itself is an investment entity.
- A parent that either ceases to be an investment entity or becomes an investment entity shall account for the change in its status prospectively from the date at which the change in status occurred
- A parent that ceases to be an investment entity will consolidate all its subsidiaries it controls prospectively from the date at which the change in status occurred and for this purpose the acquisition date will be treated as the date at which the change in status occurred
AB Ltd owns 49% voting rights in another entity. The remaining voting rights are held by large number of individuals, and each individual owns less than 1% voting rights.
None of the shareholders has any arrangements to consult any of the others or make collective decisions.
Determine whether AB Ltd has control over investee?
In this case, on the basis of the absolute size of holding owned by AB Ltd i.e. 49% and the relative size of the other shareholdings, the investor concludes that AB Ltd has a sufficient dominant voting interest in the investee to meet the power criteria and hence AB Ltd has control over investee.
AB Ltd owns 75% voting rights in another entity, while remaining 25% voting rights are held by another Investor B who also has an option to acquire half of AB Ltd’s voting rights. But the option is exercisable after next two years at a fixed price.
Determine whether AB Ltd has control over investee?
In this case, AB Ltd has existing voting rights which are more than 50% and is actively directing the relevant activities of theinvestee.
Although investor B has options to purchase additional voting rights from AB Ltd (that, if exercised, would give it a majority of the voting rights in the investee). However, these options will not be considered in determination of control over investee by investor B because these are not currently exercisable until after two years.