March 16, 2009
To: IASB Board and staff
From: Ed Trott, former FASB Board member
Subject: Comments on ED10 Consolidated Financial Statements
Overall Concern
The ED requires many difficult judgements to be made that easily could go either way in
deciding whether a control situation exists or does not exist These judgements usually
will be made without direct or obvious evidence. The sum of these judgements lead to
very difficult financial reporting about an entity. I am concerned that different
conclusions will be reached under the same circumstances.
It would be great if Preparers and Auditors could rigorously be objective and neutral in
making all accounting and financial reporting judgements and decisions. However,
experience shows that individual, entity, profession amid fear of being second guessed
bias is almost always present. The biases are usually different among parties and the
biases can change over time.
Users of financial reporting will have the information provided to them directly affected
by biases that they cannot detect or challenge. Also some of them have biases as to how
they believe consolidation decisions should be made.
I believe the following two approaches should be considered by the Board to reduce or to
make more clear the affected biases and decisions about control and consolidation
decisions.
Approach One – Reduce the Number of Decisions
One approach to increase the likelihood that the same judgement will be made in the
same circumstances (thus reducing the effect of individual biases) is for the IASB to
provide more guidance for making the judgement and/or make the distinction between
the judgements wider. An example of this would be to accept the alternative view on the
consideration of options and convertible instruments rather than trying to judge whether
B13(a) or (b) is present.
Both B13(a) and (b) require a judgement as to whether others are acting in accordance
with the reporting entity’s wishes. To determine if the others are acting according to the
reporting entity’s wishes, don’t you have to know why the other parties are acting the
way they are? Would the other parties act another way than the way the reporting entity
wishes anyway or would they prefer to act in a way other than the reporting entity?
Additional examples of applying Approach One are provided later in this letter. I
understand that this is the classic issue of how much guidance to provide to make
applying a principle operational without the guidance interfering with the principles.
Approach Two – Increasing the Transparency of the Decisions and Biases
I do not believe the guidance in B32 – B34 or the illustrations are adequate – especially
for those situations where it is decided that control exists and the other entities are
consolidated. I suggest that for entities consolidated based other than on the reporting
entity having a majority of the voting rights, the reporting entity have required
Supplementary Consolidating Information. The consolidating information would conver
the balance sheet, income statement and statement of cash flow and have the following 3
columns
Parent and Majority
+
Voting Controlled Entities
Less than Majority +
Voting Controlled
Entities
Non-Voting
= Consolidated
Controlled Entities Entity
Please note that B32- B34 nor the illustration require or show information about column
3 above.
The Supplementary Consolidation Information would be supplemented by a discussion of
the reasons the entities under the second and third column are consolidated. This display
would also be useful in communicating the information required by 48(c).
In addition to expanding information about what is controlled and consolidated, I believe
a “non-consolidated schedule” should be required. The non-consolidated schedule would
include condensed balance sheet and income statement date (even if it is labelled
“uncredited”) that would have the following three columns but without a total:
Majority Voting Interest
Entities
Dominant but not Majority
Voting Interest Entities
Significant Non-Voting
Control Entities
The non-consolidated schedule would be supplemented by a discussion of the reasons the
reporting entity decided they did not control those entities. Please note that Paragraph 48
does not require the disclosure of why the first column entities are not controlled. The
non-consolidated schedule would help put the required disclosure about the nature of and
risks associated with non-consolidated entities in context.
Additional Comments
Question 2: I agree that control, as defined in the ED, is the appropriate basis for
consolidation.
Questions 1 and 3: The guidance with respect to (1) identifying Agents, (2) deciding who
the Agent is an Agent for and (3) when to consider the powers of an Agent in making a
control decision is not adequate. Specific suggestions to expand/improve guidance in this
critical area follow:
1. Move the list in B12 into the “Agency” section
2. Expand the list in B12 to include parties that are not subject to absorbing
significant negative results
3. Providing Application Guidance (and examples) with respect to “Purpose and
Design” (Paragraph 32) and “Returns” (Paragraph 33). Although Risks and
Rewards should not be a fall-back consolidation test, I believe understanding
Risks and Rewards are key to understanding “Purpose and Design” and
identifying Agents and who the Agent is related to.
4. The discussion of “Removal Rights” needs to be expanded to cover removal
rights with respect to when the Agent works for a group of principles – such as in
a securitization entity. Evaluating removal rights can help identify who the
Agent’s power may be attributed to and when the power should be combined
with a particular principle.
5. If the guidance in BC95 is important, why is it not in the Standard or in the
Application Guidance?
6. Examples and evaluations of “dual role” situations would be helpful.
The area of “Agency” is a key area where bias can significantly affect a control decision.
This is the major area where providing application guidance is needed to reduce the affect
of bias.
Another area where Agency is key is “Power without a majority of the voting rights”. I
believe this could be explained more clearly as the holder of less than a majority of the
voting rights is acting as an Agent for the other holders of voting rights. Until the other
holders organize and/or vote in opposition of the wishes of the reporting entity, the
reporting entity effectively is the Agent for the others!
Questions 6-8: The Paragraph 30 focus on structured entities as those “whose activities
are restricted” does not capture the scope of entities where voting rights are not useful in
determining whether control exists or not. I suggest that “structured entities” be replaced
by “non-voting controlled entities”.
Although examples have risks of becoming “rules”, after working on FIN 46 and 46(R), I
believe examples should be provided for these entities.
Question 11: I do not believe Reputational Risk is an appropriate basis for consolidation.
However, in many cases I believe reputational risks essentially are implicit and/or
constructive obligations for one entity to provide support for another entity that should be
identified and reported. The B47 guidance required disclosure that is too late.
If the Board believes reputational risk should be separated from implicit and constructive
obligations, the discussion of reputational risk should be included in the standard or
application guidance.
I would be happy to discuss my comments with the Board or staff. My email address is
ewtrott@aol.com and telephone # is 203-358-8274.
Edward W. Trott.