In The Know
NEW IFRS FOR
CONSOLIDATION
– IFRS 10, IFRS 11
& IFRS 12
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IFRS 11 changes the focus of classification
of joint arrangements from the legal structure
to the nature of rights and obligations arising
from such arrangements. Only equity accounting
is allowed for joint ventures under IFRS 11 and
proportionate consolidation will no longer be
an option.
IFRS 12, in a single standard, expands
the disclosures required for interests in both
consolidated entities and unconsolidated entities.
However investment entities have been excluded
from the scope of IFRS 10 and IFRS 12 as IASB
has issued an exposure draft in August 2011 for
public comments on the proposed assessment,
measurement and disclosure requirements for
such entities.
WHO IS AFFECTED?
The entities that are most likely to be affected
include:
• Entities with significant equity interests in
other entities but may not hold majority
interest (that is, less than 50%);
• Entities holding potential voting rights such
as options over shares or convertible debt;
• Investment, fund or asset managers;
• Entities that use structured entities
(formally known as special-purpose entities);
• Entities that account for jointly-controlled
entities using proportionate consolidation;
and
• Entities that have collaborative arrangements
that may be joint arrangements
7/6;6!.L[[`0THNLZ
n the accounting realm, the word “control”
takes on a revamped identity with the release
of three new International Financial Reporting
Standards (IFRSs), namely IFRS 10 Consolidated
Financial Statements, IFRS 11 Joint Arrangements
and IFRS 12 Disclosure of Interests in Other
Entities issued by the International Accounting
Standards Board (IASB). These IFRSs are
effective for annual periods beginning on or
after 1 January 2013 but require retrospective
application. Hence, early planning is highly
recommended.
This new suite of five consolidation and
related standards, including the revised
International Accounting Standards (IAS)
27 Separate Financial Statements and IAS 28
Investments in Associates and Joint Ventures, is
released as part of the convergence project to
eliminate differences between IFRS and United
States Generally Accepted Accounting Principles
(US GAAP) and also in response to the perceived
conflict of emphasis between IAS 27 and SIC 12
Consolidation – Special Purpose Entities, which
has led to inconsistent application of the control
concept and structuring opportunities.
IFRS 10 brings the two control models for
power (as defined in IAS 27) and exposure
to returns (as defined in SIC 12) together by
introducing an additional criterion that the
investor is capable of wielding that power to
influence its returns. It does not change how
an entity is consolidated but whether an entity
is to be consolidated.
IFRS 10: CONTROL AS THE BASIS FOR
CONSOLIDATION
IFRS 10 introduces a single consolidation model that identifies
continuous control as the basis for consolidation for all types of
entities including structured entities. It identifies three elements
of control, as shown in Figure 1. An investor must possess all the
three elements to conclude that it has control over an investee.
Figure 1
Exposure to
variability in returns:
• Potential to vary according to
Power over
the investee:
• Having existing substantive
rights that give investor the
current ability to direct relevant
activities (i.e. activities that
most significantly affect the
entity’s returns)
• May arise from voting rights or any
other contractual arrangements
• Specifically excludes
protective rights
the entity’s performance
• Include both ownership-type
benefits and synergistic returns
(e.g. tax benefits or
economies of
scale, dividends,
cost savings)
Ability to
use power to
affect returns:
• Decision-making
rights to
influence returns
Control
Other considerations when assessing control include the following:
• Purpose and design of investee
To have power, the investor must be able to direct the relevant
activities, taking into consideration the purpose and design of an
investee. The relevant activities for an investee whose operations
are directed through voting rights will generally be its operating
and financing activities.
In the event that there are several investors who have the ability
to direct different relevant activities, the investor having the current
ability to direct the activities that most significantly affect the
returns of the investee is considered to have power. One such example
is illustrated in IFRS 10 “application examples” where an investee is
set up by two investors for the purpose of developing and marketing
a medical product. One investor is responsible for developing and
obtaining regulatory approval of the medical product while the other
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In The Know
investor manufactures and markets the approved medical
product. Accordingly, each investor needs to consider which
activity most significantly affects the investee’s returns and
whether the investor is able to direct that activity.
• Control with less than majority voting rights
It is also possible for an investor with less than majority
voting rights to have power when the investor can unilaterally
direct the relevant activities; this is also known as de facto
control. This would imply consideration of relative and
potential voting rights (only if they are substantive) and
any additional facts and circumstances that may be relevant,
like voting patterns at previous shareholders’ meetings.
IFRS 10, paragraph B43, contains an example of Investor A,
who has acquired 48% of the voting rights of an investee
while the remaining voting rights are held by thousands of
shareholders, none individually holding more than 1% of
the voting rights. In this case, Investor A concludes that
he has a sufficiently dominant voting interest to meet the
power criterion without the need to consider any other
evidence of power.
• Agency relationships
IFRS 10 provides explicit guidance on an agency relationship
where an evaluation of the decision-making rights will
determine which party holds the decision-making authority.
The investor shall treat the decision-making rights of an
investor’s agent as if they were held by the investor directly.
This would have a potential impact for investment and
asset managers when evaluating whether they are agents
of the fund’s board of directors. Factors to be considered in
such agency relationships would usually include the scope
of discretion of decision-making authority, rights held by
other parties, linkage of investee’s remuneration agreement
to performance and decision-maker’s exposure to variability
from interests in the investee.
IFRS 11: FOCUS ON THE NATURE OF THE
RIGHTS AND OBLIGATIONS OF JOINT
ARRANGEMENTS
As illustrated in Figure 2, a joint arrangement can either
be a joint operation or a joint venture under IFRS 11. In
determining the classification of joint arrangements, the
existence of a separate vehicle is a necessary condition, but
not sufficient for a joint arrangement to be considered a joint
venture. IFRS 11 clarifies that other factors like terms of the
contractual arrangement and relevant facts and circumstances
are to be considered as well. Hence management may need
to re-think its current classification or potential business
decisions for joint arrangements.
Figure 2
IFRS 11
IAS 311
JOINTLY-CONTROLLED OPERATIONS
Accounting method: Its share of assets, liabilities,
income and expenses
JOINT OPERATIONS
“Rights to the assets and obligations for the
liabilities relating to the arrangement”
Accounting method:
Its share of assets, liabilities,
income and expenses
JOINT VENTURES
“Rights to net assets of the arrangement”
Accounting method: Equity
JOINTLY-CONTROLLED ASSETS
Accounting method: Its share of assets, liabilities,
income and expenses
OR
JOINTLY-CONTROLLED ENTITIES
Accounting method: Proportionate consolidation
or equity
Joint arrangement is defined as a contractual agreement over which
• Two or more parties have “joint control” which is defined as the contractually agreed sharing of control of an arrangement; and
• Exists only when the decisions about the relevant activities require the unanimous consent of the parties sharing control
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IAS 31 Interests in Joint Ventures has been
superseded by IFRS 11 Joint Arrangements
Figure 3
INTERACTION BETWEEN IFRS 10, 11, 12 AND IAS 28
Control alone?
yes
no
Consolidation in accordance
with IFRS 10
Joint control?
yes
no
Define type of joint
arrangement in accordance
with IFRS 11
Significant
influence?
Disclosures in accordance
with IFRS 12
Joint Operation
Joint Venture
yes
Account for assets, liabilities,
revenues and expenses
Account for an investment in
accordance with IAS 28
Disclosures in accordance with IFRS 12
Disclosures in accordance with IFRS 12
no
IFRS 9
Source: IASB www.ifrs.org (reproduced with permission)
Jointly-controlled entities, as previously defined in IAS 311,
may be classified as joint ventures and hence accounted for
using the equity method in IFRS 11. This is one significant
change, where the choice of using proportionate consolidation
has been removed under IFRS 11. The impact of changing
from proportionate consolidation to the equity method could
be significant where such investments in jointly-controlled
entities are material to the financial statements. This would
in turn impact computations of key performance indicators
used to assess the performance of an entity, including
that used for the loan covenant compliance, analyst and
shareholders’ communications, and share-based payment
vesting conditions.
IFRS 12: ONE COMPREHENSIVE
DISCLOSURE STANDARD
The disclosure requirements in IFRS 12 are more extensive
compared to those in IAS 27 as IFRS 12 provides for
one comprehensive disclosure standard for interests in
subsidiaries, joint arrangements, associates and structured
entities. Hence, management would need to exercise a certain
degree of judgement in determining whether an investee
is controlled and therefore consolidated. For instance,
disclosure is required for how voting rights are evaluated
and whether it is a principal or an agent etc. It also introduces
the term “structured entities” which replaces and expands
upon the concept of a “special-purpose entity” that was
previously used in SIC 12.
TO CONSOLIDATE OR NOT?
Adopting these new standards will require time, effort
and the exercise of considerable judgement based on a
comprehensive understanding of the business, operations,
and legal rights and obligations. Accounting personnel should
not make such judgement calls alone and should get input
from management, operations personnel and legal counsel.
Figure 3 shows an interaction between the new IFRSs and
IAS 28 which summarises the consolidation requirements.
This article was written by Jezz Chew, Technical Manager of
ICPAS Technical.
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