First Impressions: Consolidated financial statements

Transcription

1 IFRS First Impressions: Consolidated financial statements May 2011 kpmg.com/ifrs

2 Contents Consolidation: a new single control model 1 1. Overview 2 2. How this could affect you 4 3. Understanding the project 6 4. Apply the new single control model Introduction Assessment made on a continuous basis Control vs collective control The new model at a glance 11 Appendix 1: New terms and definitions 60 Appendix 2: Status of convergence with US GAAP 61 Appendix 3: Mapping of guidance carried forward from IAS 27 (2008) 62 Appendix 4: Mapping of the new single control model guidance in IFRS About this publication Identify the investee Control over specified assets and liabilities Identify the relevant activities of the investee Range of operating and financing activities Several investors each direct different relevant activities Relevant activities occur only when particular circumstances or events occur Identify how decisions about the relevant activities are made Investee controlled by means of voting rights More complex cases When voting rights are not relevant The gating question is subject to continuous assessment Assess whether the investor has power over the relevant activities Only substantive rights are considered Voting rights Rights other than voting rights Assess whether the investor is exposed to variability in returns Assess whether there is a link between power and returns Principal vs agent Relationships with other parties Carried forward consolidation procedures Subsidiaries in separate financial statements Disclosures Aggregation Significant judgements and assumptions Interests in subsidiaries Structured entities Effective date and transition Effective date Transitional requirements for IFRS Transitional requirements for IFRS Other effects of adopting IFRS 10 and IFRS Disclosure requirements before adoption First-time adopters of IFRSs 59

3 First impressions: Consolidated financial statements 1 Consolidation: a new single control model The new consolidation and disclosure standards have, like the joint arrangement standard that accompanies them, been long in the making. Coming out of the financial crisis, there were concerns among some that existing consolidation and disclosure standards failed adequately to portray the risks that investors in certain entities were exposed to. Complicating things further is the fact that these entities are described in a variety of different ways, including special purpose entities in IFRS, variable interest entities in US GAAP, and also special purpose vehicles and structured entities in practice. Further adding to the challenge is the fact that IFRS previously had two different consolidation models: one for special purpose entities and another for all other investees. In its new consolidation standard, IFRS 10, the IASB has stated that its objective is to develop a single consolidation model applicable to all investees. That model states that an investor consolidates an investee when it has power, exposure to variability in returns, and a linkage between the two. That being said, it appears that there remains a gating question, as IFRS 10 has different control indicators for situations in which voting and potential voting rights are important to the determination of power over an investee, and for situations in which other factors are important. In the early stages of the application of IFRS 10, it is unclear whether investees for whom factors other than voting rights are important are more similar to special purpose entities or to variable interest entities or perhaps they are entirely different. Further, exposure to variability in returns is a broader concept than ownership benefits or risks and rewards. Returns can include not only ownership benefits such as dividends and changes in the value of the investment, but also fees, remuneration, tax benefits, economies of scale, cost savings and other synergies. The IASB also has explicitly introduced the concepts of principal vs agent and de facto control. The principal/agent analysis could be particularly important for industries such as funds, asset management and real estate. The explicit inclusion of de facto control could introduce changes in practice since, in our experience, most apply the current consolidation standard, IAS 27, on the basis of legal rather than de facto control. Overall, implementation of IFRS 10 and the accompanying disclosure standard, IFRS 12, will require significant judgement, in several respects. While the standards are not mandatorily effective until periods beginning on or after 1 January 2013, we expect that preparers will want to begin evaluating their involvement with investees under the new consolidation and disclosure standards sooner than that, as changes in the consolidation conclusion under the new standard generally will call for retrospective application. In the meantime, we trust that this publication will assist companies in understanding what needs to be done to apply the standards; and assist investors understanding of what is driving the different information that they will begin to see as companies begin to report on this basis. Paul Munter Mike Metcalf Julie Santoro KPMG s global IFRS Business Combinations and Consolidation leadership team KPMG International Standards Group

4 2 First impressions: Consolidated financial statements 1. Overview Apply the new single control model Identify the investee Identify the relevant activities of the investee Identify how decisions about the relevant activities are made Assess whether the investor has power over the relevant activities Control involves power, exposure to variability in returns and a linkage between the two. Exposure to risks and rewards does not, on its own, determine that the investor has control. It is one factor in the analysis. Control is assessed on a continuous basis, i.e. it is reassessed as facts and circumstances change. A change in market conditions does not trigger a reassessment of the control conclusion unless it changes one or more of the elements of control, e.g. whether potential voting rights are substantive. The investor considers the purpose and design of the investee so as to identify its relevant activities, how decisions about such activities are made, who has the current ability to direct those activities, and who receives returns therefrom. Control is usually assessed over a legal entity, but also can be assessed over only specified assets and liabilities of an investee (referred to as a silo see Appendix 1). The investor considers whether it controls the relevant activities (see Appendix 1) of the investee. There is a gating question in the model, which is to determine whether voting rights or rights other than voting rights are relevant when assessing whether the investor has power over the investee. Substantive rights Only substantive rights held by the investor and others are considered. To be substantive, rights need to be exercisable when decisions about the relevant activities need to be made, and their holder needs to have a practical ability to exercise the rights. Voting rights An investor can have power over an investee when the relevant activities are directed through voting rights in the following situations: the investor holds the majority of the voting rights, and these rights are substantive; or the investor holds less than half of the voting rights but has an agreement with other vote holders, holds rights arising from other contractual arrangements, holds substantive potential voting rights, holds rights sufficient to unilaterally direct the relevant activities of the investee (de facto power) or holds a combination thereof.

5 First impressions: Consolidated financial statements 3 Assess whether the investor has power over the relevant activities (continued) Assess whether the investor is exposed to variability in returns Assess whether there is a link between power and returns Rights other than voting rights When holders of voting rights as a group do not have the ability to significantly affect the investee s returns, the investor considers the purpose and design of the investee as well as the following factors: evidence that the investor has the practical ability to direct the relevant activities unilaterally; indications that the investor has a special relationship with the investee; and whether the investor has a large exposure to variability in returns. The first of these three factors is given the greatest weight in the analysis. Returns are defined broadly and include distributions of economic benefits and changes in the value of the investment, as well as fees, remunerations, tax benefits, economies of scale, cost savings and other synergies. An investor that has decision-making power over an investee determines whether it acts as a principal or as an agent. When the decision maker is an agent, the link between power and returns is absent and the decision maker s delegated power is treated as if it were held by its principal(s). To determine whether it is an agent, the decision maker considers: substantive removal and other rights held by a single or multiple parties; whether its remuneration is on arm s length terms; and the overall relationship between itself and other parties, through a series of factors. An entity takes into account the rights of parties acting on its behalf when assessing whether it controls an investee. Carried forward consolidation procedures Accounting for subsidiaries in separate financial statements Disclosures Effective date and transition Accounting requirements for subsidiaries in consolidated financial statements are carried forward from IAS 27 (2008) Consolidated and Separate Financial Statements. Accounting requirements for separate financial statements are carried forward by IAS 27 (2011) Separate Financial Statements. Enhanced disclosures are required, including specific disclosures for consolidated and unconsolidated structured entities. IFRS 10 is effective for annual periods beginning on or after 1 January Early adoption is permitted. IFRS 10 is applied retrospectively when there is a change in the control conclusion. There are specific requirements when retrospective application is impracticable.

6 4 First impressions: Consolidated financial statements 2. How this could affect you IFRS 10 Consolidated Financial Statements provides a revised definition of control and related application guidance. It replaces IAS 27 (2008) and SIC 12 Consolidation Special Purpose Entities and applies to all investees. This publication focuses on those requirements that are modified and that are expected to have an impact on the preparers and users of financial statements. Key changes Judgemental approach Single control model applies to all investees Identification of investee activities explicitly required De facto control included in the model Potential impacts The approach comprises a series of indicators of control, but no hierarchy is provided: it requires an analysis of all facts and circumstances and the application of judgement in making the control assessment. For example, the standard emphasises the need to understand the design and purpose of an investee and stresses the need to take into account evidence of power, which are likely to be highly judgemental areas. Therefore, IFRS 10 is likely to be a difficult standard to apply across many sectors and first-time implementation efforts may be significant, including staff training, impact assessment, policy development etc. The control conclusion could change for SPEs currently in the scope of SIC 12. As a result, entities in the financial services sector could be impacted, and to a lesser extent entities in the real estate sector. We also expect that there will be investees currently not in the scope of SIC-12 for which rights other than voting rights are relevant in assessing control. This could be the case in the infrastructure and energy sectors. The control conclusion could change in respect of investees in which several investors each have the ability to direct different activities. More investees could be consolidated if an entity currently assesses the ability to control on a legal or contractual basis under IAS 27 (2008), which is, in our experience, the more common application of the standard. Even if an entity assesses the ability to control based on de facto circumstances under IAS 27 (2008), applying the implementation guidance in IFRS 10 could lead to a different conclusion. In effect, in our experience, the current concept of de facto control does not necessarily take into account the active or passive nature of other shareholders, but rather considers how many other shareholders are expected to vote in the same way as the investor. Beyond this, there will be other practical consequences for preparers. For instance, the assessment of de facto control requires knowledge about the investor s substantive rights and also insight into other shareholders. In practice, it may be challenging for an entity to gather this information, especially at the point at which the dominant shareholding position is established. As a consequence, at the date the investor acquires a dominant (but not a majority) interest in an investee, it may conclude that it does not have de facto control over the investee, and might eventually do acquisitionlike accounting twice: for the first time, when it acquires significant influence through the dominant but non-controlling interest in order to equity account the investment; and again when it concludes that it has de facto control.

7 First impressions: Consolidated financial statements 5 Key changes Control assessed based on substantive potential voting rights as opposed to currently exercisable potential voting rights Exposure or right to variability in returns replaces the concept of benefits Principal vs agent guidance explicitly introduced Guidance provided on when an investor would assess power over silos instead of over a legal entity Protective rights are defined and explicit guidance on kick-out rights is introduced More disclosures about consolidated and unconsolidated entities Potential impacts Determining whether rights are substantive under IFRS 10 will require more judgement than determining whether they are currently exercisable under IAS 27 (2008). It appears that the intent of the party writing or purchasing the potential voting right would be taken into account in the analysis. Management will need to monitor potential voting rights to determine whether they are substantive, which could include the need to assess the investor s practical ability to exercise those rights, for example. This is likely to change the control conclusion in some cases: currently exercisable potential voting rights might not be considered substantive and vice versa. Variability in returns is a much broader concept than ownership-type benefits and is not solely a risks and rewards analysis. As a result, it may impact the control conclusion, particularly when benefits under IAS 27 (2008)/SIC-12 were interpreted as ownership-type benefits and those benefits were widely dispersed. A number of indicators are provided to analyse whether a decision maker is acting as a principal or as an agent when directing the activities of an investee. While all facts and circumstances need to be considered, some entities may find it difficult to assess whether their remuneration is commensurate with that of other service providers or whether the removal rights held by other parties are substantive. Entities in the funds sector, as well as asset managers, are likely to be particularly impacted by this guidance. Explicit guidance on silos does not exist in IAS 27 (2008), which is likely to change the control conclusion over a silo and the entity in which it is housed in some cases. Entities in the financial services and potentially the real estate sectors could be particularly impacted by this change. Guidance is provided on the rights of other parties; such guidance does not exist in IAS 27 (2008). In our experience, preparers of IFRS financial statements generally use the guidance on participating rights and protective rights in US GAAP. However, the definition of protective rights in US GAAP is different from IFRS 10. As a consequence, the analysis could differ from current practice. Entities in the funds and real estate sectors could be particularly impacted by this guidance. Entities will need to assess whether they have an involvement in investees that meet the definition of structured entities, as specific disclosures are required. Internal controls and systems may need to be upgraded to capture the information needed for the new disclosure requirements.

8 6 First impressions: Consolidated financial statements 3. Understanding the project The consolidation project was among the first IASB/FASB convergence projects and has been on the IASB s agenda since However, not much progress was made on the project until In 2008, as a result of the financial crisis, the project became a priority project for the IASB with two main objectives: Develop a single enhanced consolidation model so as to reduce structuring opportunities and to ensure that an entity consolidates all entities that it controls. Develop detailed disclosure requirements such that an entity provides useful information in relation to investees that it does not consolidate. In addition to IFRS 10, the IASB has issued (or plans to issue) the following: IFRS 12 Disclosure of Interests in Other Entities, requiring enhanced disclosures about involvement with consolidated and unconsolidated entities; IFRS 11 Joint Arrangements, together with IAS 28 (2011) Investments in Associates and Joint Ventures; IAS 27 (2011), which carries forward the existing accounting requirements for separate financial statements; and an exposure draft (expected to be issued in the second quarter of 2011) that will propose changes related to the consolidation of investees by investment companies. The FASB s perspective is further discussed in Appendix 2. This publication discusses the contents of IFRS 10, the IFRS 12 disclosure requirements for subsidiaries and unconsolidated structured entities, and the IAS 27 (2011) requirements for subsidiaries in separate financial statements. Our publication First Impressions: Joint arrangements discusses IFRS 11, IAS 28 (2011) and the IFRS 12 disclosure requirements for joint arrangements and associates. The following table presents the requirements for subsidiaries standard by standard and highlights the main contents of this publication. Requirements for subsidiaries 2008 standards 2011 standards Section of this publication Exemptions from preparing consolidated financial statements IAS 27 (2008) IFRS 10: requirements similar to those of IAS 27 (2008) Section 11 Determination of entities to be consolidated Control model in IAS 27 (2008) Risks and rewards model in SIC-12 for SPEs IFRS 10: new single control model applied to all investees Sections 4 to 10 Consolidation procedures IAS 27 (2008) IFRS 10: requirements substantially the same as those of IAS 27 (2008) Section 11 Separate financial statements IAS 27 (2008) IAS 27 (2011): requirements substantially the same as those of IAS 27 (2008) Section 12 Disclosures IAS 27 (2008) IFRS 12: significantly expanded disclosures Section 13

9 First impressions: Consolidated financial statements 7 4. Apply the new single control model 4.1 Introduction IFRS 10.6, 7, A, B2 An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. IFRS 10.10, 14, B9 IFRS 10.11, 12, B40 IFRS 10.B2-B8 To have power, it is necessary for the investor to have existing rights that give it the current ability to direct the activities that significantly affect the investee s returns, i.e. the relevant activities. An investor can have power over an investee even if other parties have existing rights to participate in the direction of the relevant activities, e.g. significant influence over the investee. The above definition of power is based on ability. Therefore, power does not need to be exercised. Conversely, evidence that the investor has been directing the relevant activities is not in itself conclusive in determining that the investor has power over the investee. Also, in the absence of other rights, economic dependence of an investee on the investor does not result in the investor controlling the investee. Sometimes the assessment of control is straightforward: the investee is clearly controlled by means of equity instruments and the investor holding a majority of the voting rights controls the investee. In other cases the assessment is more complex and requires a number of factors to be considered (see 4.4). IFRS 10.B4 The investor considers the nature of its relationships with other parties when assessing control (see 10.2). Insight Definition of control can appear repetitive IFRS 10.A, BC61, BC62 At first glance, the definition of control can appear repetitive, as the definitions of control and power both refer to returns. In effect, power is defined as the current ability to direct the activities of the investee that significantly affect the investee s returns. However, directing the returns-generating activities of an investee (definition of power) is different from an investor having the ability through its power to generate returns for itself (definition of control). Insight Current ability to direct the relevant activities Care should be taken about the meaning of current ability to direct the relevant activities. In order to have control, an investor should be able to control the most significant decisions, but it is not necessary for these decisions to be made right now. This is further discussed in the context of potential voting rights (see 8.2.4).

10 8 First impressions: Consolidated financial statements Main change from IAS 27 (2008) and SIC-12 For SPEs currently in the scope of SIC-12, the change from a risk and rewards model to a control model is likely to change the consolidation conclusion in some cases. At this early stage in the application of IFRS 10, it seems difficult to point out precisely the situations in which this is likely to occur. However, the IASB has provided examples of such situations in its Project Summary and Feedback Statement. These examples are as follows: Example 1 Investment vehicle V is created to purchase a portfolio of financial assets, funded by debt and equity instruments issued to a number of investors. Investor M holds 30 percent of the equity and is also the asset manager managing V s asset portfolio within portfolio guidelines. This management includes decisions about the selection, acquisition and disposal of the assets within those portfolio guidelines and the management upon default of any asset in the portfolio. Analysis under IFRS 10 The analysis provided under IFRS 10 is that M controls V, as M has the ability to direct the relevant activities, rights to variable returns from the performance of the vehicle and has the ability to use its power to affect its own returns. It is however not entirely clear how it has been concluded that M is acting as a principal (see section 10), and whether potential contractual arrangements with debt investors have been considered. Example 2 Analysis under SIC-12 It is assumed in the analysis that V is an SPE in the scope of SIC-12. The analysis provided under SIC-12 is that some would conclude that M does not consolidate the investment vehicle, based on the fact that M does not bear the majority of risks and rewards. Vehicle S is set up to provide Institutional investor B with investment opportunities that expose B to Entity Z s credit risk. Z is unrelated to S and B. S issues notes that are linked to Z s credit risk to B and invests in a portfolio of high quality financial assets. S obtains exposure to Z s credit risk by entering into a credit default swap agreement (CDS) with a bank in return for a fee, with the portfolio of assets as collateral. There are very few if any decisions to be made after set up. B does not have the ability to direct activities that significantly affect S s returns.

11 First impressions: Consolidated financial statements 9 Analysis under IFRS 10 The analysis provided under IFRS 10 is that B does not consolidate S. Although B receives substantially all of the returns, and is exposed to substantially all of the risks of S, B has no means of managing that exposure or of accessing or directing the net assets of S. B does not have power over S and by way of consequence does not control S. Analysis under SIC-12 It is assumed in the analysis that S is an SPE in the scope of SIC-12. The analysis provided under SIC-12 is that B consolidates S. This is because B receives substantially all of the returns and is exposed to substantially all of the risks of S. In addition, S was created for the benefit of B. Instead, B is required to provide the disclosure requirements for unconsolidated structured entities. The Project Summary and Feedback Statement also states that although an investor may conclude under IFRS 10 that it does not consolidate an investee that it used to consolidate under SIC-12, the effect of deconsolidation will be mitigated by the derecognition requirements for financial instruments in a number of cases. In effect, if the investor has transferred assets to a vehicle for which it bears the majority of risks and rewards, even if it does not control the vehicle under IFRS 10, then typically it will not derecognise the assets transferred to the vehicle. 4.2 Assessment made on a continuous basis IFRS 10.8, B80-B84 The assessment of control is performed on a continuous basis and the investor reassesses whether it controls an investee if facts and circumstances indicate that there are changes to one or more of the elements of control, that is to: power, e.g. substantive rights held by other parties elapse; returns, e.g. the investor ceases to receive returns; or linkage between power and returns, e.g. the investor no longer acts as an agent or vice versa. Determining how decisions about the relevant activities are made is also assessed on a continuous basis (see 7.4). Insight An analysis is not required in each period A clean slate analysis of control is not required in each period. The entity continues with its previous analysis until facts and circumstances indicate that there are changes to one or more of the elements of control. Insight Continuous assessment and de facto control In practice, issues may arise when an investor needs to assess whether it has de facto control over an investee. When the investor holds less than a majority of voting rights, determining the date on which the investor obtains de facto control of the investee (see 8.2.5) may be a challenging issue. At the date that an investor initially acquires less than a majority of voting rights in an investee, the investor may assess that it does not have de facto control over the investee if it does not know how other shareholders are likely to behave. As time passes, the investor obtains more information about other shareholders, gains experience from shareholders meetings and may ultimately assess that it does have de facto control over the investee. Determining the point at which this happens is likely to require significant judgement.

12 10 First impressions: Consolidated financial statements Also, if the date that de facto power is obtained is later than the date that the investment in the investee is acquired originally, then the investor may need to do the acquisition-like accounting twice if the investee is a business: first when the initial investment is acquired, if the investor has significant influence over the investee and needs to allocate the cost to the underlying net assets of the investee to apply the equity method; and again when de facto control is obtained to apply the requirements of IFRS 3 Business Combinations for step acquisitions. This could also result in a gain being recognised in profit or loss at that date. IFRS 10.B85 IFRS 10.BC124 A change in market conditions does not trigger a reassessment of the control conclusion unless it changes one or more of the three elements of control or the overall relationship between a principal and an agent (see section 10). A change in market conditions alone typically should not cause potential voting rights to become substantive or cease to be substantive. This is because determining whether potential voting rights are substantive is a holistic analysis that takes into account a variety of factors, including market conditions (see 8.2.4). Insight Impact of changes in market conditions There could be circumstances in which changes in market conditions, coupled with other factors, could result in a different conclusion about whether potential voting rights are substantive and therefore trigger a reassessment of the control conclusion. In such a case, the guidance in IFRS 3 (step acquisition) or IFRS 10 (loss of control) should be followed. Our publication Insights into IFRS ( and ) discusses these requirements in the context of IFRS 3 (if the investee is a business) and IAS 27 (2008). Insight Investees in which voting rights are not relevant As the control analysis is very judgemental for investees in which voting rights are not relevant, the requirement to reassess control on a continuous basis is likely to be more difficult to implement. Main change from IAS 27 (2008) and SIC-12 The current standards do not state explicitly that control is assessed on a continuous basis, but in our experience this is normally the case in practice. In the context of SPEs, our publication Insights into IFRS ( ) states that the assessment of whether or not an entity has control over an SPE is carried out at inception and that normally no further reassessment of control is carried out in the absence of changes in the structure or terms of the SPE, or additional transactions between the entity and the SPE. It also clarifies that day-to-day changes in market conditions normally do not lead to a reassessment of control. 4.3 Control vs collective control IFRS 10.9 If two or more investors must act together to direct the relevant activities of an investee, then they can collectively control the investee. In this case if no single investor can direct the activities of the investee without the co-operation of another investor, then no investor controls the investee. The investors assess whether the investee is a joint arrangement, an associate or an investment to which financial instrument accounting applies. See our publication First Impressions: Joint arrangements (3.3.2) for further discussion of this issue.

13 First impressions: Consolidated financial statements 11 A situation in which several investors have collective control over the same relevant activities of an investee is different from a situation in which several investors each direct different relevant activities of an investee. The latter case is discussed in The new model at a glance IFRS 10.B2, B3 The diagram below is a general presentation of the analysis to be performed in order to determine whether the rights held by the investor give it control over the investee.

14 12 First impressions: Consolidated financial statements No hierarchy is provided in the model IFRS 10.8 The investor considers all relevant facts and circumstances when assessing whether it controls an investee. The approach comprises a collection of indicators of control, but no hierarchy is provided: it requires an analysis of all facts and circumstances and the application of judgement in making the control conclusion. As explained in 4.1, in straightforward cases the investor that has the majority of the voting rights in an investee will control that investee. In some cases, the assessment will be more complicated and the investor will need to go through one or more of a series of factors, which are illustrated as being some of the steps in the above diagram. This diagram presents the logical flow that an investor will follow to assess whether it controls an investee. However, IFRS 10 does not prescribe any order to be followed for the analysis and does not require an investor to go through all of the steps presented in the diagram Consideration of purpose and design Purpose and design as a high-level consideration IFRS 10.B5 The investor considers the purpose and design of the investee at various steps of the analysis. First it is considered so as to identify: the relevant activities; how decisions about such activities are made; who has the current ability to direct those activities; and who receives returns therefrom. The purpose and design of the investee in this context seems to be an item of high-level consideration in the analysis. Purpose and design in the context of potential voting rights IFRS 10.B48 Consideration of the purpose and design of the investee is also considered in the context of an investor holding potential voting rights. As explained in 8.2.4, this consideration includes an assessment of the terms and conditions of the rights as well as the reasons for agreeing to them. Purpose and design in the context of investees not controlled by means of equity instruments IFRS 10.B51, B53 Also, as presented in the diagram, purpose and design are considered when rights other than voting rights are relevant in assessing whether an investor controls an investee. As explained in 8.3.1, this includes consideration of involvement in the investee s design, decisions, contractual arrangements made at the investee s inception, investees with predetermined activities and situations in which an investor has a commitment to ensure that the investee continues to operate as designed. Purpose and design in the context of principal vs agent analysis IFRS 10.B63 Purpose and design of the investee also are considered when assessing whether a decision maker is a principal or an agent. This is particularly relevant when assessing the scope of the decision-making authority (see ). Purpose and design, and disclosures IFRS 12.B7 Purpose and design also are considered when assessing whether disclosures are required (see section 13).

15 First impressions: Consolidated financial statements Identify the investee The term investee is not defined in IFRS 10. However, it is used throughout IFRS 10 as an entity or a deemed entity that is or may be a subsidiary of the investor. Insight Investor and investee not defined IFRS 10.BCZ182 Other standards, and even some paragraphs in the basis for conclusions in IFRS 10 may use the terms investor and investee with another meaning, e.g. investor as an entity that does not have control over an investee, as opposed to a parent; and investee as an entity that is not a subsidiary. 5.1 Control over specified assets and liabilities IFRS 10.B76, B77 Control by an investor generally is assessed at the level of the legal entity. In some cases, however, an investor has power over only specified assets and liabilities of an entity and treats that portion of the entity as a deemed separate entity. This is referred to as a silo (see Appendix 1) for the purpose of applying the new consolidation requirements. This would apply only if: in substance, the assets, liabilities and equity of the silo are separate from the overall entity such that none of those assets can be used to pay other obligations of the entity and those assets are the only source of payment for specified liabilities of the silo; and parties other than those with the specified liability, have no rights or obligations related to the specified assets or to residual cash flows from those assets. Example Silo structure Two companies, X and Y, transfer trade receivables and credit enhancements to vehicle V, which issues commercial paper, thereby acting as the refinancing vehicle for X and Y. There is no crosscollateralisation of the transferred assets. Because there is no cross-collateralisation, each originator, X and Y, assesses whether it controls its specific silo, which includes the receivables transferred as financial assets and its specified commercial paper liability.

16 14 First impressions: Consolidated financial statements IFRS 10.B79 If one party controls a silo, then other parties exclude the assets and liabilities of the silo when assessing control and consolidation of the entity. The entity or deemed entity for which control is assessed by the investor is referred to as the investee. Insight Silo different from unincorporated entity IAS 27.4 A silo is different from an unincorporated entity in IAS 27 (2008) and SIC-12. An unincorporated entity is an entity that has the same characteristics as a company but is not incorporated; it can for example be a partnership. We would normally expect silos to be present within entities that are currently SPEs in the scope of SIC-12, in the context of multi-seller SPEs and more generally in the financial services sector. Ringfenced assets also sometimes arise in the real estate sector. Care and a robust analysis will be required in assessing whether the specific criteria of IFRS 10 are met to conclude that a legal entity contains silos. Main change from IAS 27 (2008) and SIC-12 IAS 27 (2008) and SIC-12 do not include specific guidance for situations in which an investor has power over only specified assets and liabilities of an investee. Our view in relation to silos in the context of SPEs under SIC-12 is set out in our publication Insights into IFRS ( ). However, for entities other than SPEs, this is new guidance since IFRS 10 does not distinguish between SPEs and other investees.

17 First impressions: Consolidated financial statements Identify the relevant activities of the investee IFRS 10.A Relevant activities of the investee are the activities of the investee that significantly affect the investee s returns (see Appendix 1). IFRS 10.BC56-BC59 The reference to activities that significantly affect the investee s returns has been introduced in IFRS 10 to provide explicit guidance on which activities of an investee should be considered when assessing control. This is particularly relevant for entities with predetermined activities when activities until a specific event are only administrative activities with little or no effect on the investee s returns. The more an entity s activities are predetermined, the more important the design of the investee is in evaluating power over the relevant activities. IFRS 10.13, B11-B13, B53 There may be investees: with a range of operating and financing activities significantly affecting their returns (see 6.1); for which several investors each direct different relevant activities (see 6.2); or for which relevant activities occur only when particular circumstances or events occur (see 6.3). Insight Judgement required Determining the activities that significantly affect the returns of an investee will be a highly judgemental area in some cases. Main change from IAS 27 (2008) and SIC-12 IAS 27 (2008) and SIC-12 do not include any guidance on the relevant activities of an investee for the purpose of assessing control. 6.1 Range of operating and financing activities IFRS 10.B11, B12 In many investees, a range of operating and financing activities significantly affect returns: sales of goods, management of financial assets, acquisitions and disposals of operating assets, management of research and development activities, and determination of the funding structure. In such cases, the decisions affecting the returns may be linked to decisions such as establishing operating and capital decisions, e.g. budgets, and appointing, remunerating and terminating key management personnel or other service providers. 6.2 Several investors each direct different relevant activities IFRS 10.13, B13 There can be investees in which several investors each have the ability to direct different relevant activities. In such cases, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power. This principle also applies if different relevant activities occur at different times.

18 16 First impressions: Consolidated financial statements IFRS 10.BC85-BC91 Investees with multiple parties having decision-making rights can arise when the assets are managed by one party and the funding is managed by another party, or in the case of multi-seller conduits or multi-seller securitisations. Example Direction over relevant activities split IFRS 10.B13 Two investors, B and C, form an investee that is engaged in the development of a medical product and intends to manufacture and market the product subsequent to its development. B has the unilateral ability to make decisions related to development, and C has the unilateral ability to make decisions about manufacturing and marketing. All of the activities are relevant activities. Each investor needs to determine the activity that most significantly affects the investee s returns, considering the following factors: the purpose and design of the investee; the factors that determine the profit margin, revenue and value of the investee as well as the value of the medical product; the effect of each investor s decision-making authority on the investee s returns; the investors exposure to variability of returns; the uncertainty of, and effort required to obtain, regulatory approval; and which investor controls the medical product once the development phase is successful. Insight Single control conclusion We would expect the conclusion reached in respect of which of investor B and C has power to be valid for the whole of the project, and not just at one moment in time, unless facts and circumstances change. Main change from IAS 27 (2008) and SIC-12 The conclusion reached under current standards would not necessarily be the same as that reached under IFRS 10. Under IAS 27 (2008)/SIC-12, the investor would determine first whether or not the investee is an SPE. Generally an entity that intends to manufacture if research and development is successful would not be an SPE. Assuming that the investee is not an SPE, under IAS 27 (2008), depending on the voting rights held by each investor and others, it could be concluded that neither investor has control (or joint control) and that each investor has only significant influence over the investee.

19 First impressions: Consolidated financial statements Relevant activities occur only when particular circumstances or events occur IFRS 10.B53 There can also be investees for which relevant activities occur only when particular circumstances arise or events occur, as the direction of activities is predetermined until this date. In this case, only the decisions when those events occur can affect the returns significantly and therefore be relevant activities. Example Relevant activity triggered by default IFRS 10.B53 The only assets of an investee are receivables and the only relevant activity is managing the receivables upon default. The fact that this activity only arises in the event of a default is not taken into account in assessing control; and the probability of default is not considered in the analysis because this is the only decision that can affect the returns significantly. Therefore, the investor with the power over this activity has control even prior to default.

20 18 First impressions: Consolidated financial statements 7. Identify how decisions about the relevant activities are made IFRS 10.B6 Determining how decisions about the relevant activities are made is key in the IFRS 10 approach and represents a gating question in the control analysis. This gating question seeks to determine whether voting rights are relevant in assessing whether the investor has power over the investee, i.e. the investee is controlled by means of voting instruments; or voting rights are not relevant in assessing whether the investor has power over the investee, i.e. the investee is controlled by means of other rights. Depending on the answer to this gating question, a different analysis will be performed to assess which investor has power over the investee. 7.1 Investee controlled by means of voting rights IFRS 10.11, B6 IFRS 10.B6 When the investee is controlled by means of equity instruments, with associated and proportionate voting rights, the assessment of power focuses on which investor, if any, has voting rights sufficient to direct the investee s relevant activities, absent any additional arrangements that alter the decision making. In the most straightforward cases, the investor holding the majority of the voting rights has power over (and controls) the investee. See 8.2 for further discussion about the evaluation of control through voting and potential voting rights More complex cases IFRS 10.B3, B7 For more complex cases, a number of factors are relevant for (1) assessing what is determinative in assessing control, i.e. voting or other rights; and then (2) identifying the controlling party. This will involve an analysis of: what the purpose and design of the investee is; what the relevant activities are; how decisions about the relevant activities are made; whether the investor is exposed or has rights to variable returns from its involvement with the investee; and whether the investor has the ability to use its power over the investee to affect the amount of the investor s returns. 7.3 When voting rights are not relevant IFRS 10.B8 Some investees are designed so that voting rights are not relevant to the determination of power, but instead other rights are relevant. These entities generally correspond to structured entities as defined in IFRS 12 (see 13.4). In such cases, consideration of the purpose and design of the investee includes consideration of: the risks that the investee was designed to create; the risks that the investee was designed to pass on to the parties involved in the transaction; and whether the investor is exposed to some or all of these risks.

21 First impressions: Consolidated financial statements 19 The consideration of risks includes both downside risk and the potential for upside return. Such investees are discussed further in 8.3. Insight Scope broader than SIC-12 SPEs IFRS 12.BC84 We expect that entities currently in the scope of SIC-12 will generally be investees that are designed so that voting rights are not relevant. However, we also expect that there will be investees currently not in the scope of SIC-12 for which rights other than voting rights are relevant in assessing control. The mapping table in Appendix 4 shows which paragraphs of IFRS 10 are applicable for the evaluation of control for investees for which voting rights are relevant and which are applicable for other investees. 7.4 The gating question is subject to continuous assessment As stated in 4.2, determining how decisions about the relevant activities are made is assessed on a continuous basis: changes in the decision-making rights can for example imply that the relevant activities are no longer controlled by means of equity instruments but by means of contractual rights. Example Change in relevance of voting rights Company S is set up as an entity controlled by means of equity instruments. Company L holds 60 percent of the voting rights in S, and Companies M and N each hold 20 percent. There are no arrangements that alter decision making in S, and it is concluded that L controls S. During its first years of activity, S incurs significant unexpected losses so that its net assets become negative. M agrees to provide significant financing to S to continue development of its activities and in return obtains the right to appoint some of the key management personnel who direct the relevant activities of S as well as the right to approve budgets in the ordinary course of business. In this example, it could be determined that S has become an entity in which voting rights are not relevant.

22 20 First impressions: Consolidated financial statements 8. Assess whether the investor has power over the relevant activities IFRS IFRS 10.11, B14, B15 An investor has power over an investee when the investor has existing rights that give it the current ability to direct the activities that significantly affect the investee s returns. Power arises from rights. Different types of rights, either individually or in combination, can give an investor power over the significant activities of an investee. Those include current and potential voting rights, rights to appoint or remove members of the investee s key management personnel or governing body, and decision-making rights arising from a management contract or other contracts. The diagram below presents the steps followed to assess whether the rights held by the investor give it power.

23 First impressions: Consolidated financial statements Only substantive rights are considered IFRS 10.B22 IFRS 10.B24 IFRS 10.B25, BC106 For the purpose of assessing power, only substantive rights held by the investor and other parties are considered. An investor is explicitly required to consider both substantive rights that it holds and substantive rights held by others. While in many cases this will lead to a similar conclusion as the current practice of evaluating substantive participating rights, in some cases it could differ from current practice, e.g. in respect of kick-out rights. To be substantive, rights need to be exercisable when decisions about the relevant activities need to be made, and the holder needs to have a practical ability to exercise those rights. Substantive rights exercisable by other parties can prevent an investor from controlling the investee, even if they only give their holders the ability to approve or block decisions that relate to the investee s relevant activities. This also can apply when other parties hold potential voting rights, kick-out rights or similar rights Determining whether rights are substantive IFRS 10.B23 Determining whether rights are substantive requires judgement taking into account all available facts and circumstances. Factors to consider include: Example Exercise of voting rights in relation to relevant activities IFRS 10.B24 Investee S, whose activities are controlled through voting rights, has annual shareholder meetings at which decisions to direct the relevant activities are made. The next shareholder meeting is scheduled for eight months time. However, shareholders can call a special meeting to change the existing policies over relevant activities, but a requirement to give notice to the other shareholders means that such a meeting cannot be held for at least 30 days. Each scenario below is considered in isolation.