Lesson 2 The Accounting Principles Framework. Università degli Studi di Trieste D.E.A.M.S. Paolo Altin

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1 Lesson 2 The Accounting Principles Framework Università degli Studi di Trieste D.E.A.M.S. Paolo Altin 36

2 The Accounting Principle Framework IAS 27 Separate Financial Statements How investor shall present its investments in the individual accounts. IAS 28 Investments in Associates IFRS 3 Business Combinations How to account for associates (investments where you have a significant influence (20%-50%) but not control). Defines and describes the equity method of accounting. It defines what business combinations are and how to identify them. Recognition and measurement principles of how investors shall treat the goodwill, non-controlling interests and identifiable assets and liabilities acquired in the bc. 37

3 The Accounting Principle Framework IFRS 10 Consolidated Financial Statements Directly related to IFRS 3 Defines the control Requires an investor to present consolidated financial statements Estabilishes the consolidation procedures. Execptions: the investment entities that don t need the consolidation process. IFRS 11 Joint Arrangements It deals with: joint ventures and joint operations. It defines them and prescribes the accounting treatment for them. 38

4 The Accounting Principle Framework IFRS 12 Disclosure of Interests in Other Entities Prescribes all the necessary information you need to disclose about subsidiaries, associates and joint arrangments and other entities. 39

5 IFRS 10 IFRS 10 estabilishes principles for the presentation and preparation fo consolidated financial statements when an entity controls one or more other entities. IFRS 10 objective is to prescribe a single consolidation model for all entities based on control, irrespective of the nature of the investee (wether an entity is controlled through voting rights of investors or through other contractual arrangements). IFRS 10 does not deal with the accounting requirements for business combinations and their effects on consolidation, including goodwill arising on consolidation (IFRS 3) nor does the Standard deal with the accounting requirements in the separate financial statements (IAS 27). 40

6 Types of interest in other entities Subsidiary Interest Associate Interest Joint Arrangements Investment Interest Ownership 50% or more 20% - 49% Joint <20% Accounting Standards Accounting treatment IFRS 3 IAS 28 IFRS 11 IFRS 9 Control = consolidation Significant influence = Equity Method Joint Operation = it depends. Joint Ventures = Equity Method At fair value 41

7 Joint arrangements keywords Joint arrangement: An arrangement of which two or more parties have joint control. Joint control: The contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. Joint operation: A joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Joint venture: A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. 42

8 IFRS 10 Requires an entity (the parent) that controls one or more other entities (subsidiaries) to present consolidated financial statements. Defines the principle of control and establishes control as the basis for consolidation. Sets out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee. Sets out the accounting requirements for the preparation of consolidated financial statements. Defines an investment entity and sets out an exception to consolidating particular subsidiaries of an investment entity. 43

9 The definition of control Consolidation is based on control. Control may be obtained in various manners, and not only as a result of the power to direct the financial and operating policies. Exposure to risks/rewards is one of the factors necessary to the existence of control, but it is never the determining factor. IFRS 10 requires extensive use of judgement. IFRS 12 requires disclosure of areas of judgement. IFRS 10 use the term: Investor to refer to a reporting entity that potentially controls one or more other entities. Investee to refer to an entity that is, or may potentially be, the subsidiary of a reporting entity. A party can be an investor and potentially control another party, without having a direct financial interest in that party. 44

10 The definition of control An investor controls an investee when it 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. Having power, without being able to affect those returns using that power, would not demonstrate control. This principle applies to all investees, including structured entities ( special purpose entities ). 45

11 The definition of control Consequently, for an investor to control an investee, the investor must possess all of the following: 1. Power over the investee, which is described as having existing rights that give the current ability to direct the activities of the investee that significantly affect the investee s returns (such activities are referred to as the relevant activities ). 2. Exposure, or rights, to variable returns from its involvement with the investee. 3. Ability to use its power over the investee to affect the amount of the investor s returns. 46

its involvement with the investee and has the ability to

12 The definition of control An investor controls an investee when it 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. 47 Deloitte

13 The definition of control 48 Ernst&Young

14 Power Power arises from substantive rights to direct the relevant activities. 49 Deloitte

15 Determination of whether control exists 50 Deloitte

16 De facto control (IFRS 10) Examples of situations where an investor may have power with less than majority of voting rights. 51 Deloitte

17 De facto control (IFRS 10) Does Alpha have the control on Rug? Alpha specializes in the design and manufacturing of carpets. It owns 100% of Rug Co, which operates in the same industry. Alpha decides to make Rug Co a publicly traded entity, retaining 30 per cent of the equity (and related voting rights) of Rug Co. The other 70 per cent of the voting rights are widely distributed among thousands of shareholders, none individually holding more than 1 per cent of the voting rights. At the time of retaining the 30 per cent voting interest, Alpha signed a contract with Rug Co that allows Alpha to manage and operate all of the activities of Rug Co. Rug Co has no employees of its own. In order to cancel the management and operations contract with Alpha, approval by 75 per cent of the votes attached is required. 52

18 De facto control (IFRS 10) Yes. Given the ability of Alpha to direct the relevant activities of Rug Co through the combination of the contractual arrangement and the 30 percent voting interest, Alpha would conclude that it controls Rug Co and thus should consolidate that entity. Alpha s 30 percent shareholding in Rug Co prevents other parties from changing the contractual arrangement Alpha uses to direct the relevant activities of Rug Co (i.e., the contract between Alpha and Rug Co cannot be changed without Alpha s approval). 53

19 Determination of whether control exists 54 Deloitte

20 Assessing power: complex situations 55 Deloitte

21 Determination of whether control exists 56 Deloitte

22 The exception A parent is not required to (but may) present consolidated financial statements if and only if all of the following 4 conditions are met: 1. the parent is itself a wholly-owned subsidiary, or is a partiallyowned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements; 2. its debt or equity instruments are not traded in a public market; 3. it did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market; and 4. its ultimate or any intermediate parent of the parent produces CFS available for public use that comply with IFRS. 57

23 The loss of control Derecognise: the assets (including any goodwill) and liabilities of the subsidiary at their carrying amounts at the date when control is lost; and the carrying amount of any non-controlling interests in the former subsidiary at the date when control is lost (including any components of other comprehensive income attributable to them). 58

24 The loss of control Recognise: the fair value of the consideration received, if any, from the transaction, event or circumstances that resulted in the loss of control; if the transaction, event or circumstances that resulted in the loss of control involves a distribution of shares of the subsidiary to owners in their capacity as owners, that distribution; and any investment retained in the former subsidiary at its fair value at the date when control is lost. 59

25 The loss of control Reclassify: to profit or loss, or transfer directly to retained earnings if required by other IFRSs, the amounts recognised in other comprehensive income in relation to the subsidiary. 60

26 The disclosure Bolzoni Group Deloitte 61

27 The disclosure 62 Bolzoni Group Deloitte

28 The disclosure Fiat Group Deloitte 63

29 The disclosure Fiat Group Deloitte 64

30 Business Combinations 65

31 Business Combinations The consolidation of financial information into a single set of statements becomes necessary when the business combination of two or more companies creates a single economic entity. A business combination refers to a transaction or other event in which an acquirer obtains control over one or more businesses. Business combinations are formed by a wide variety of transactions or events with various formats. 66

32 Business Combinations 67

3 This IFRS shall be applied by all entities that are a party to a joint arrangement.

3 This IFRS shall be applied by all entities that are a party to a joint arrangement. International Financial Reporting Standard 11 Joint Arrangements Objective 1 The objective of this IFRS is to establish principles for financial reporting by entities that have an interest in arrangements