Ind-AS 110 Consolidated Financial Statements

Transcription

1 Ind-AS 110 Consolidated Financial Statements Hemal D. Shah The Chamber of Tax Consultants

2 Topics Background, objectives and core principle New definition of control Assessing control Investment entities Page 2

3 Background, objectives and core principle Background Ind-AS 110 based on IFRS 10, which was issued due to inconsistent application of the concept of control Global financial crisis highlighted the lack of transparency about risk of exposure from off-balance-sheet vehicles Objectives Develop a single control model that is applicable to all types of entities Improve disclosures Core principle A group presents consolidated financial statements as those of a single economic entity Consolidated financial statements include all controlled entities Page 3

4 Ind-AS 110- Scope, exemption and exceptions Exemption from preparing consolidated financial statements for a parent if: it is a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and all its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting CFS; its debt/ equity instruments are not traded in a public market; it did not file/in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and its ultimate or any intermediate parent produces CFS that are available for public use and comply with Ind-AS Scope exclusion Post employment benefit plans and other long-term employee benefit plan to which Ind-AS 19 applies Exception from consolidation generally to investment entities Page 4

5 Few Issues Accounting for employee share based payment trusts? Consolidation-Can immaterial subsidiaries be exempted? Requirement to prepare consolidated financial statements where an entity disposes off its single investment in a subsidiary/ associate/ joint venture? Page 5

6 Interaction between Ind-AS 110, 111, 112 & Ind-AS 28 Does the investor control an entity by itself Yes No Consolidation in accordance with IndAS 110 Does the investor have joint control over an arrangement? Disclosures in accordance with IndAS 112 Yes No Joint Operation Classify joint arrangement in accordance with IndAS 111 Joint Does the investor Venture Yes have significant No influence over an entity? Account for assets, liabilities, revenue and expenses Account for interest under the equity method Financial Instrument Other IndAS* Disclosures in accordance with IndAS 112 & other relevant standards Disclosures in accordance with IndAS 112 Disclosures in accordance with IndAS 112 & other relevant standards * This would be the case, for example, if an entity has control over (or simply rights to) assets and obligations for liabilities, but not control of an entity. In this case, the entity would account for these assets and obligations in accordance with the relevant IndAS Page 6

7 New 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. Ind-AS 110 Power Returns Linkage AS 21/ Power IAS 27 + Power to govern the financial and operating policies of an entity SIC-12 Risks + Benefits Obtain benefits from its activities Rewards Page 7

8 Assessing control Power Returns Linkage Determine which party if any, has power, that is, the current ability to direct relevant activities. Power arises from the rights which may include u Voting rights u Potential voting rights (eg. Options or convertible instruments) u Rights to appoint key personnel u Decision making rights within a management contract. u Removal or kickout rights However power does not arise from protective rights. Assess whether the investor is exposed or has rights to variable returns from its involvement with the investee. Returns can be positive, negative, or both. Example of returns include u Dividends u Remuneration u Economies of scale, cost savings, scarce product, proprietary knowledge, synergies, or other returns that are not available to other interest holders. Understand purpose and design of investee Continuous assessment Evaluate whether the investor has the ability to use its power to affect the investor s returns from its involvement with the investee applicable. Determine whether the investor is a principal or an agent considering u Scope of its authority u Rights held by other parties u Remuneration u Exposure to variability from other interests Page 8

9 New definition of control Identifying relevant activities Relevant activities are those that significantly affect the investee s returns Examples: Establishing operating, capital and financing policies Determining funding structure or obtaining funding Appointing, remunerating, and terminating employment of service providers or key management personnel Understand purpose and design of the investee If two investors direct different relevant activities Identify which investor can direct the activities that most significantly affect returns Page 9

10 Relevant activities example 1 Enterprises A and B form a venture, Ice Cream Co. The purpose and design of Ice Cream Co. is to manufacture, distribute and sell ice cream Each enterprise contributes cash and receives equity interest Enterprises A and B are unrelated How should the enterprises determine which party controls Ice Cream Co.? A B Ice Cream Co. Page 10

11 Relevant activities example 1 (contd. ) 1. Consider the purpose and design and the risks Ice Cream Co. was designed to distribute 2. Identify the relevant activities 3. Identify the party or parties with the current ability to direct the relevant activities 4. Assess whether the investor is exposed to returns Relevant activity Manufacturing Distributing Selling Responsible party Enterprise A Enterprise B Enterprise B Page 11

12 Relevant activities example 2 A & B form an investee to develop and market a medical product A responsible for developing and obtaining regulatory approval Once approval is received, B will manufacture and market it A s discretion B s discretion Development Manufacturing & marketing Regulatory approval Page 12

13 Relevant activities example 2 (contd. ) Purpose and design of the investee Factors that determine profit margin, revenue and value of the investee as well as the value of medical product Effect on the investee's returns resulting from each investor's decision-making authority with respect to the above factors Investors' exposure to variability of returns Uncertainty of, and effort required in, obtaining regulatory approval Consider historical trend Who controls medical product once development phase is successful Page 13

14 Identifying relevant activities Example 3 Two investors, C and D, form an investee E to acquire, dispose and manage an investment property portfolio (fund). Investor C is responsible for acquisitions and disposals of the investment properties of the portfolio whilst investor D is responsible for the management of the existing investment properties of the portfolio. The investment agreement states that the fund will hold no more than five investment properties at any one time, and indicates a planned Internal Rate of Return (IRR) on each property. If an investment property achieves an IRR less than planned for three consecutive years, investor C is required to evaluate whether the investment property needs to be replaced considering the forecast of the respective investment property, the overall return of the portfolio of investment properties and available properties in the market. Page 14

15 Identifying relevant activities Example 3 (cont.) Key points The level of activity associated with the acquisition and disposal of investment properties is based on the expected IRR of both the individual investment properties and the fund. If IRR levels are expected to be achievable and realistic on the properties initially acquired, then the level of acquisition and disposal activities would be low and the most relevant activity will therefore be the management of the investment properties. If the level of activities relating to acquisitions and disposals is high and is expected to remain high, this may indicate that the acquisitions and disposals of investment properties are the most relevant activity. Page 15

16 New definition of control Evaluating power Power is having existing rights that give an investor the current ability to direct the relevant activities Main aspects of power: Arises from rights (voting, potential voting, contractual arrangements or combination) Need not be exercised Does not arise from protective rights Can exist even if others participate in directing the relevant activities (e.g., they have significant influence) Evidence that an investor directed activities in the past is an indicator of power, but is not conclusive Page 16

17 Substantive rights Factors to consider in assessing whether a right is substantive: Are there barriers that would prevent the holder from exercising their rights? Do the holders have the practical ability to exercise their rights when exercise requires agreement by more than one investor? Would the investor that holds the rights benefit from their exercise of conversion? Are the rights currently exercisable or convertible? Page 17

18 New definition of control Assessing returns Returns can be only positive, only negative or positive and negative, but must have the potential to vary as a result of the investee s performance Examples: Dividends, distributions of economic benefits, FV changes Remuneration, fees, residual interests, tax benefits Synergies, cost savings, economies of scale, Other parties may also share in the returns, e.g. NCI Returns that appear fixed may actually be variable Exposure to returns is an indicator of control: Greater the exposure greater incentive to obtain power Page 18

19 Power Protective rights Franchises Will a franchisor consolidate the franchisee under Ind-AS 110? Page 19

20 Power Protective rights Franchises A franchise agreement often gives the franchisor rights, which generally: Are designed to protect the brand Do not have a significant effect on franchisee s returns Assess whether rights give franchisor power: Who benefits from activities of franchisee? What are the relevant activities? How was the franchisee established and structured? How does the franchisor support the franchisee? What is franchisor s exposure to variability of returns? Page 20

21 What is different/ more explicit? Protective rights/ current ability Power with less than majority voting rights Potential voting rights Delegated rights Power over specified assets ( silos ) Page 21

22 Power De facto control An investor may have the power with less than half of the voting rights Consider all facts and circumstances Contractual arrangements with other shareholders Contractual rights arising from other arrangements Size of investor s voting rights Voting rights - Absolute amount and relative to other vote holders Number of other vote holders that will need to act together Voting patterns at previous shareholders meetings Potential voting rights If it is not clear from considering these factors that the investor has power, the investor does not control the investee. Page 22

23 Power De facto control Examples 1 and 2 Example 1 Example 2 52% widely dispersed 1% 1% 1% 26% 26% A 48% B C 45% D Page 23

24 Power De facto control Examples 3 and 4 Example 3 Example 4 50% widely dispersed, half turn up at AGM 5% 5% 5% 50% widely dispersed, half turn up at AGM 4% 4% 4% J 35% K L 38% M Page 24

25 Audit Challenges De facto control How should the exact date at which control is obtained (or lost) be determined? How is the exact date at which the other investors became widely dispersed determined? How large should an investor s interest be relative to other vote-holders, or how widely dispersed must they be for the investor to have power? How relevant are past voting patterns? How far should you look back? How will you gather all information? Past voting patterns Relationships between other shareholders Page 25

26 Potential voting rights Potential voting rights are only considered in assessment of power if they are substantive. Factors to be considered when evaluating if options are substantive: Exercise price or conversion price, relative to market terms Ability to obtain financing Timing and length of exercise period Other aspects to be considered: Purpose and design of the instrument Investor s apparent expectations, motives and reasons for agreeing the terms of the instrument Other involvement the investor has with the investee Page 26

27 Potential voting rights Page 27

28 Assessing power potential voting rights example 1 Investor A holds 70% of the voting rights of C. Investor B holds 30% of the voting rights of C as well as a currently exercisable fixed-price option to acquire half of A s voting rights. Option is deeply out of the money (and expected to remain so over the exercise period of two years). A is actively directing the activities of C. Key points Fixed price option is deeply out of money and is therefore not substantive in nature. If an option is deeply out of the money (and expected to be so for the term), paying the exercise price is likely to be considered a barrier. A has the current ability to direct the relevant activities. Investor A has power over C. Page 28

29 Assessing power potential voting rights example 2 Investor A and two other investors each hold one third of the voting rights of an investee. The investee s business activity is closely related to investor A. A holds convertible debt instruments that could be converted at any time for a fixed price that is not deeply out of the money and that would bring A to a shareholding of 60% if exercised. A would benefit from synergies if the debt instrument is converted. Key points The convertible instrument held by A are not deeply out of the money. A would benefit from realising synergies if the debt instruments were converted. A has the current ability to direct the relevant activities of the investee Investor A has power over the investee. Page 29

30 Audit challenges Potential voting rights When is the exercise/conversion price considered a barrier? Could financing be obtained? When are options deeply out of the money? What period do you consider? When are options currently exercisable? Would the holder benefit from the exercise? How will you gather information? Do other shareholders have potential voting rights, barriers, or incentives that you are unaware of? Continuous assessment is a challenge. Page 30

31 Power Delegated rights Overview An agent is a party engaged to act on behalf of another party or parties (the principal(s)) A principal may delegate some or all decisionmaking authority to the agent An agent does not control an investee All facts and circumstances must be considered Principal? Agent? Page 31

32 Delegated rights link between power and returns Broad scope of decisionmaking powers Removal rights Large number of parties Remuneration not commensurate with services provided Greater exposure to variability of returns from all interests Narrow scope of decisionmaking powers Removal rights Single party or small number of parties Remuneration is commensurate with services provided Little exposure to variability of returns from all interests More likely principal More likely agent Decisionmaker Based on considering all factors, rather than a single factor Page 32

33 Power Delegated rights Exposure to variability through other interests Are any interests held by related parties? Greater the magnitude of, and variability associated with, its economic interests, more likely it is a principal Page 33

34 Relationships with other parties De facto agents Consider whether the investor has the ability to direct other parties (i.e., de facto agents ) to act on its behalf? Examples: Related parties A party that cannot finance its operations without subordinated financial support from the investor A party with same Board or key management personnel Rights and returns of de facto agents are considered together with investor s own, when evaluating control Page 34

35 Defacto Agent Example 1 A Ltd, a manufacturing company, will lose significant tax benefit if it sells goods outside its own selling territory A Ltd therefore sets itself up as company selling within its territory B Ltd is set up for purchase from manufacturing company and selling in other territories B Ltd has very thin equity capital, held by related parties B Ltd has practically no finance, no inventory, purchases all the supplies from the manufacturing company, is operated at low margin level and uses manufacturing company infrastructure for sale to customers Under Ind AS 110 B Ltd is likely to be consolidated by A Ltd Page 35

36 Control of specified assets silos If an investor has control of specified assets of an investee, it treats that portion ( silo ) of the investee as a separate entity if all apply Specified assets are the only source of payment for specified liabilities/other interests in the investee Parties other than those with the specified liabilities do not have rights or obligations related to the specified assets or to residual cash flows from those assets None of the returns from the specified assets can be used by the remaining investee None of the liabilities of the deemed separate entity are payable from the assets of the remaining investee In other words, is there a ring-fence? Page 36

37 Control of specified assets - Example A,B and C each lease separate buildings (Building A,B and C respectively) that are owned by the lessor/investee. A,B and C are considered investors because they may be controlling the investee or silo within the investee. A has a fixed price purchase option to purchase Building A for 120. No such option for Building B or C The investee s balance sheet stated at fair value Page 37

38 Control of specified assets - example (contd. ) Silo exists for Building A No silo exists for Building B or C Although there is debt that is recourse only to the building, the debt is only 50% of the fair value of Buildings B and C Remaining fair value is supported by equity that also supports the investee s other assets Page 38

39 Continuous assessment Reassess if facts and circumstances suggest change to one of criteria of control Examples: Changes to how activities are directed Changes in exposure to variable returns Market conditions change: If affect one of control criteria re-evaluate control If do not affect one of control criteria no re-evaluation Page 39

40 Continuous assessment Example A holds 40% of the voting rights of B It also holds currently exercisable in-the-money option to acquire a further 20% voting rights of B A will have likely power over B, because A can currently exercise its right to obtain majority of B s voting shares. In-the-money option changed to being slightly (but not deeply) out-of-the-money: Will probably not trigger re-assessment Option changed to being deeply-out-of-the-money Will likely trigger re-assessment Page 40

41 Power De facto control Before After 52% widely dispersed 11 investors hold 52% shares A 48% B A 48% B Page 41

42 Audit challenges Judgement required to assess which party has control over another entity, based on facts and circumstances no bright lines' May result in changes to the entities being consolidated and will impact key metrics of financial performance: Assessment of impact on debt covenants and management remuneration Communication with stakeholders Consideration of new guidance when new arrangements are negotiated or existing ones are modified Additional procedures required to assess control on a continuous basis (information gathering regarding investee and behaviour of other shareholders) Page 42

43 Investment entities An entity that: Obtains funds from one or more investors for providing those investor(s) with professional investment management services Commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income or both Measures and evaluates the performance of substantially all of its investments on a fair value basis. Page 43

44 Investment entities Typical characteristics: Has more than one investment, to diversify the risk portfolio and maximize returns Has multiple investors, who pool their funds to maximize investment opportunities Has investors that are not related parties of the entity Has ownership interests in the form of equity or similar interests Page 44

45 Investment entities scope exception Investment entities should not consolidate controlled investments Measure investments at fair value through profit or loss Exception for certain subsidiaries A parent of an investment entity should consolidate all subsidiaries it controls Unless the parent itself is an investment entity Page 45

46 Investment entities Page 46

47 Consolidation procedures- Losses of subsidiary IndAS 110 Subsidiary s losses allocated between the parent and NCI, even if this results in deficit NCI balance. Indian GAAP Subsidiary s losses attributed to MI, but MI can not be a deficit balance, except to the extent that the minority has a binding obligation to and is able to make good the losses. Page 47

48 Consolidation procedures- Reporting periods IndAS 110 Financial statements of the parent and subsidiaries used in the preparation of the CFS will be prepared as at the same reporting date. When reporting dates are different, adjustments are made for the effects of significant transactions or events that occur between that date and the date of the parent s financial statements, unless it is impracticable to do so. Indian GAAP Similar to Ind-AS, except that the difference between reporting dates should not be more than 6 months. Difference between the reporting dates can not be more than 3 months. Page 48

49 Consolidation procedures- NCI/ Minority interest IndAS 110 NCI presented in the consolidated balance sheet within equity, separately from the equity of the owners of the parent. Profit/loss attributable to NCI in the group P&L separately presented. Indian GAAP MI presented in the consolidated balance sheet separately from liabilities and equity of the parent's shareholders. Minority interests in the profit or loss of the group should also be separately presented. Page 49

50 Consolidation procedures- Uniform accounting policies IndAS 110 Uniform accounting policies mandatory. Indian GAAP Uniform accounting policies mandatory. If it is not practicable to use uniform accounting policies in preparing the CFS, that fact should be disclosed together with the proportions of the items in the CFS to which the different accounting policies have been applied. Page 50

51 Consolidation procedures- Changes in ownership interest that does not result in loss of control IndAS 110 Changes in the ownership interest of a subsidiary not resulting in loss of control accounted for as an equity transaction and do not impact Goodwill/ P&L Indian GAAP No specific guidance under AS 21. This has resulted in existence of diverse practices on the matter. Page 51

52 Consolidation procedures-loss of control IndAS 110 In calculating the gain/loss arising from the loss of control, retained interest in the former subsidiary is measured at its fair value at the date when control is lost. Indian GAAP In calculating the gain/loss arising from the loss of control, retained interest in the former subsidiary is measured at proportionate amounts of its carrying value at the date when control is lost. Page 52

53 Consolidation procedures- Inter group elimination IndAS 110 Intra-group balances and transactions, including income, expenses and dividends, are eliminated in full. Deferred tax should be calculated on temporary differences that arise from the elimination of profits and losses resulting from intra-group transactions. Indian GAAP Similar to Ind-AS, except that no deferred tax is recognized on elimination of intragroup transactions. Page 53

54 Few Other Issues Applying the equity method for transactions with NCI recognised through equity by the associate Accounting for a non-controlling interest s share of losses previously allocated to the parent Transaction costs incurred to acquire outstanding noncontrolling interest? Page 54

55 Questions? Page 55