ifrs 10 and 12 cpd september 2013

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IFRS 10 Consolidated Financial Statements (including investment entities) and related disclosures in IFRS 12

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Agenda

• Objective of consolidated financial statements and the link to the conceptual framework

• Reasons for issuing IFRS 10• Scope, concepts, requirements and examples• Estimates and other judgements• Disclosure (IFRS 12)• Investment entities• Effective date and transition

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Objective of consolidated financial statements and

the link to the conceptual framework

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Introduction

• Focus: preparation and presentation of consolidated statements in accordance with IFRS 10 Consolidated Financial Statements

• Consolidated financial statements present financial information about the group (ie a parent and its subsidiaries) as a single economic entity

• IFRS 10 Consolidated Financial Statements requires an entity that is a parent to present consolidated financial statements (except in very limited circumstances)

• Main judgement : identification of subsidiaries

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Why consolidation?

• Question: Why are entities required to present consolidated financial statements?

– Provide information about economic entity– investors need information about all assets and

liabilities of combined entity

– Definition of asset based on control: – with control, entity can dictate use or settlement– control through an entity is indirect control

– Do not want legal form to dictate financial reporting

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Link to the Conceptual Framework

Information must be useful to users in making decisions about providing resources to the entity

Assessment of entity’s prospects for future net cash inflows

Resources of the entity + claims against the entity + how efficiently and effectively entity’s resources are used

Core principle of IFRS 10: if control, information must be consolidated (resources, claims, etc as a single economic entity)

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Relevant

Faithfully represents economic

phenomena

Fundamental qualitative

characteristics

Information about the economic entity (ie one or more investees under a common controlling entity) is a useful input to users in predicting future outcomes (predictive value).

Information about the economic entity (ie a group) includes information about ALL recognised resources and ALL recognised claims and the effectiveness and efficiency in using such resources (complete).

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ENTITY DENTITY B ENTITY C

ENTITY A (INVESTOR)

CONTROLS CONTROLS DOES NOT CONTROL

ECONOMIC ENTITY

Investors Lenders Othercreditors

PRIMARY USERS OF FINANCIAL INFORMATION

Consolidated financial

information(A+B+C)

Investment in D is an asset in A’s statement of

financial position

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Reasons for issuing IFRS 10

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Reasons for issuing IFRS 10

The IASB’s objective in issuing IFRS 10 was to improve the usefulness of consolidated financial statements by developing a single basis for consolidation and robust guidance for applying that basis to situations in which it has proved difficult to assess control in practice.

The basis for consolidation is control and it is applied irrespective of the nature of the investee.

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Scope, concepts, requirements and

examples

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Scope of IFRS 10

• An entity that is a parent shall present consolidated financial statements (IFRS 10.4).

– A parent is an entity that controls one or more entities– A subsidiary is an entity that is controlled by another

entity (ie the parent)– A group is a parent and its subsidiaries

• Consolidated financial statements are the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.

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Interaction: IFRSs 7, 9, 10, 11 & 12 and IAS 28

noyes

yes no

noJoint VentureJoint Operation

Control alone?

Consolidation in accordance with IFRS 10

Joint control?

Define type of joint arrangement in accordance with IFRS 11

Significant influence?

Account for assets, liabilities, revenues and expenses

Disclosures in accordance with IFRS 12

Account for an investment in accordance with IAS 28



yes

IFRS 9 (or IAS 39)

Disclosures in accordance with IFRSs 7 and 13

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Scope of IFRS 10—ExceptionsA parent need not present consolidated financial statements if:• it is itself a wholly-owned subsidiary;• its securities are not publicly traded or in the process of

becoming publicly traded; and• its parent publishes IFRS-compliant financial

statements that are available to the public.

This is also the case for a partly-owned subsidiary if its other owners have been informed about, and do not object to, it not presenting consolidated financial statements.

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Scope of IFRS 10—Exceptions continued

• IFRS 10 does not apply to post-employment benefit plans or other long-term employee benefit plans to which IAS 19 Employee Benefits applies.

• IFRS 10 provides an exception from the requirements of consolidation for an investment entity which is instead required to measure its subsidiaries at fair value through profit or loss (annual periods beginning on or after 1 January 2014).

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The control model—an overview

control

Link power-returns

Exposure to

variable returns

Power

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.

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Assessing control of an investee

Rights

Relevant activities

Exposure (or rights) to

variable returns of

the investee

Ability to use power over the

investee to affect its

own returns

POWER EXPOSURE LINK

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Assessing power over an investee

POWER

• Power = existing rights that give it the current ability to direct the relevant activities

• Power arises from rights (eg voting

rights, rights to appoint key personnel, among others)

• Relevant activities: significantly affect the investee’s returns

Rights

Relevant activities

An investor need not have absolute power to control an investee

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Power—the ‘ability approach’

• Power over an investee = existing rights that give it the current ability to direct the relevant activities, ie the activities that significantly affect the investee’s returns.

• Current ability to direct the relevant activities = investor is able to make decisions at the time that those decisions need to be taken.

– Can have current ability even if it does not actively direct– An investor is not assumed to have current ability to

direct simply because is actively directing activities

• Having the current ability is not limited to being able to act today.

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Power—rights

• Only substantive rights must be considered in assessing power.

• For a right to be substantive, the holder must have the practical ability to exercise that right.

• To be substantive, rights also need to be exercisable when decisions about the direction of the relevant activities need to be made.

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Power—rights

• Voting rights• Potential voting rights• Contractual rights• Removal or ‘kick out’ rights• An investor that holds only protective rights does not

have power

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Example 1A:* power do rights give power?

• Investor A holds 45% of the voting rights of an investee.

• Eleven other investors each hold 5% of the voting rights.

• No contractual agreement among shareholders to consult any of the others or make collective decisions.

* Refer to Example 7 in paragraph B45 of IFRS 10 Consolidated Financial Statements

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Example 1B:* powerdo rights give power?

• Investor A holds 45% of the voting rights of an investee.

• Two other investors each hold 26% of the voting rights.

• Remaining voting rights are held by three other shareholders (each with 1%).

• No other arrangements that affect decision-making.


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Example 1C:* powerdo rights give power?

• An investor acquires 48% of the voting rights of an investee.

• Remaining voting rights held by thousands of shareholders, with less than 1% each.

• None of the shareholders has any arrangements to consult any of the others or make collective decisions.


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Example 1D:* powerdo rights give power?

• Investor A holds 35% of the voting rights of an investee. • Three other investors each hold 5% of the voting right. • Remaining voting rights are held by numerous other

shareholders (each holding 1% or less).• Decisions about relevant activities require approval of a

majority of votes.• Recent relevant meetings: 75% of voting rights have

been cast.


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Example 1E:* powerdo rights give power?

• Investor A holds 48% of the voting rights of an investee. The remaining voting rights are held by numerous other shareholders, none individually holding more than 1% of the voting rights.

• No arrangements to consult others or make collective decisions. • Decisions about the relevant activities require the approval of a

majority of votes cast at relevant shareholders’ meetings. 70% of the voting rights of the investee have been cast at recent relevant shareholder meetings—except for one meeting when 78% of the voting rights were cast. Decisions taken at that meeting included changing the financing arrangements (ie could affect future dividend payments to shareholders).

• There are no other contractual arrangements that would affect the assessment of power.

* Refer to Example 1 in the section ‘Control without a majority of voting rights’ of the Effect Analysis for IFRS 10 and IFRS 12

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Example 2:* powerdo rights give power?

• Investor A holds 40% of the voting rights of an investee. • Twelve other investors each hold 5% of the voting

rights.• Shareholder agreement: investor A has the right to

appoint, remove and set the remuneration of management responsible for directing the relevant activities. Two-thirds majority vote of the shareholders is required to change the agreement.


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Example 3A:* rightsdo rights give power?

• Investor A holds 70% of the voting rights of an investee. • Investor B has 30% of the voting rights of the investee

as well as an option to acquire half of Investor A’s voting rights.

• Option exercise = any time in next two years, fixed price (deeply out of the money and is expected to remain so)

• Investor A: exercises its votes and actively directs relevant activities of the investee.


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Example 3B:* powerdo rights give power?

• Investor A and two other investors each hold a third of the voting rights of an investee.

• Investor A: also holds debt instruments that are convertible into ordinary shares, fixed price, out of the money but not deeply out of the money.

• If converted, Investor A would hold 60% of the voting rights.

• The investee’s business activity is closely related to investor A (ie there are synergies).


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Example 3C:* powerare rights substantive?

• Investor A holds 40% of the voting rights of Investee B as well as an option to acquire another 20% of the voting rights from Investor C, who holds 30% of the voting rights.

• The option is exercisable during 51 weeks in each calendar year; however, it is not exercisable during the last week of every year. The option is exercisable for a nominal amount.

• Decisions about the relevant activities require the approval of a majority of the votes cast at relevant shareholders’ meetings, which are generally held during the first or second quarter of the year.

* Refer to Example in the section ‘Potential voting rights’ of the Effect Analysis for IFRS 10 and IFRS 12

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Example 3D–3G:* powerfact pattern

• The next scheduled shareholders’ meeting is in eight months.

• Shareholders with at least 5% of the voting rights can call a special meeting to change the existing policies (notice requirement prevents meeting from being held for at least 30 days).

• Policies over the relevant activities: changed only at special or scheduled shareholders’ meetings.


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Examples 3D–3G:* powerdo rights give power?

• 3D: An investor holds a majority of the voting rights.• 3E: An investor is party to a forward contract to acquire the

majority of shares (forward contract’s settlement date in 25 days).

• 3F: An investor holds a substantive option to acquire the majority of shares (exercisable in 25 days, deeply in the money).

• 3G: An investor is party to a forward contract to acquire the majority of shares (forward contract’s settlement date in six months).


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Power—relevant activities

• Relevant activities significantly affect the investee's returns

• For many investees, a range of operating and financing activities significantly affect their returns. Examples:

– selling and purchasing of goods or services– making capital expenditures or obtaining finance

• A higher degree of judgment is particularly required when assessing control of investees that are not directed through voting or similar rights and for which there may be multiple parties with decision-making rights over different activities.

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Example 4:* powerassessing the relevant activities• Two investors (A and B) form an investee to develop and

market a medical product. • Investor A: in charge of developing and obtaining regulatory

approval of the medical product. • Once the regulator has approved the product, Investor B will

manufacture and market it. • Investor B has the unilateral ability to make all decisions

about the manufacture and marketing of the project.


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Example 5:* powerability to direct relevant activities?

• Investor A, whose business is the production and sale of cheese, establishes and initially owns 100% of an operation (Investee B), which also produces and sells cheese.

• Investor A then decides to make Investee B a publicly traded entity, retaining 30% of voting rights (the other 70% are widely distributed among thousands of investors , none individually holding more than 1%).

• Investor A also signed a contract with Investee B to manage and operate all of the activities of Investee B. Investee B has no employees of its own.

• A supermajority vote of 75% is required to cancel the management and operations contract.

* Refer to Example 2 in the section ‘Control without a majority of voting rights’ of the Effect Analysis for IFRS 10 and IFRS 12

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Example 6:* powerassessing the relevant activities

• Investee’s only business: purchase receivables and service them on a day-to-day basis for its investors.

• Upon default of a receivable the investee automatically puts the receivable to Investor A (put agreement between the investor and the investee).

• Managing the receivables upon default is relevant because it is the only activity that can significantly affect the investee’s returns.


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Example 7:* powerassessing relevant activities

• Investor A transfers receivables to Investee B (created solely for purchasing and servicing those receivables).

• Investee B fully funds the acquisition of the receivables by issuing two different tranches of debt: a senior tranche (90% of the debt) to the market and a junior tranche (10% of the debt) to Investor A.

• There are few, if any, activities to perform once Investee B is set up unless the counterparties to the receivables default on payment. Investor A retains the customer relationships and manages receivables in the event of default. A third-party service provider collects the cash flows from the receivables and passes them to the investors.

* Refer to Example 1 in the section “Moving away from ‘bright lines’ “of the Effect Analysis for IFRS 10 / IFRS 12

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Example 8:* relevant activitiesability to direct relevant activities?

• Corporation A (credit card company)—arrangement with Investee B (transfers short-term credit card receivables to B) in a revolving structure.

• Investee B issues securities to market investors, backed by the receivables in two different tranches: the senior tranche (market investors) + the junior tranche (Corporation A); Senior tranche = priority in default; junior tranche = absorbs a majority of risks/rewards of B.

• Corp. A customer relationships with the counterparties to the credit card receivables + responsibility for managing recoverability of the receivables in default (renegotiating the terms of current outstanding receivables or future transactions with those customers).

• A third party service provider is employed to collect the receivables and pass the cash flows on to Investee B.


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variable returns of

the investee



own returns

EXPOSURE LINK

Rights

Relevant activities

POWER

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Assessing exposure (or rights) to variable returns


variable returns of

the investee

EXPOSURE

• Definition of control: concept of returns is used in two ways

– power ability to direct relevant activities (ie directing inconsequential activities is not relevant to assessment of power)

– rights, or exposure, to variable returns

• Broad definition of returns:

dividends; remuneration from services, fees and exposure to losses; residual interests on liquidation; tax benefits; access to future liquidity; returns not available to other investors (eg synergies)

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Exposure or rights to variable returns

• An investor is exposed, or has rights, to variable returns from its involvement with the investee when the investor’s returns from its involvement have the potential to vary as a result of the investee’s performance.

• The investor’s returns can be only positive, only negative or both positive and negative.

• Although only one investor can control an investee, more than one party can share in the returns of an investee. For example, holders of non-controlling interests can share in the profits or distributions of an investee.

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Example 9:* exposureexposed to variable returns?

• Fund Manager A manages a mutual fund, Fund B, which is created to maximise profit for its investors. Fund Manager A determines the investment policy and strategy for the mutual fund.

• Corporation C owns 55% of the shares (the rest of the shares are distributed among the other investors, with none of them individually holding more than 1%).

• None of the investors can unilaterally change the investment policy and strategy of Fund B, and nor can the investors remove Fund Manager A without cause. The investors can redeem their interests at any time within particular limits established in the fund’s constitution.

• Fund Manager A receives a market-based management fee of 2% of the net asset value in the fund, which is commensurate with the services that Fund Manager A provides to Fund B.


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variable returns of

the investee



own returns

EXPOSURE LINK

Rights

Relevant activities

POWER

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Assessing the link between power and returns



own returns

LINK

• Power + rights = necessary conditions for control (but still not enough)

• To control an investee, an investor must also have the ability to use its power to affect investor’s returns from its involvement with the investee

• Control = power that can be used to benefit the investor

• Returns and power: need not be perfectly correlated

• Only one party can control an investee

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Link between power and returns

• A case of power without control is the agency relationship.

• An agent is a party contracted by a principal to perform some service on behalf of the principal that involves delegating some authority to the agent.

• Agent– acts in the best interests of the principal (fiduciary

responsibility)– principal and agent seek to maximise their own benefits– additional measures to ensure the agent does not act

against the interests of the principal

• Delegated power does not mean control.

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Link between power and returns

• Consider all of the following factors in assessing whether an investor is acting as a principal or as an agent:

– rights held by other parties (ie kick-out rights)– scope of the decision-making authority– remuneration of the decision-maker– other interests that the decision maker holds in the

investee

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Example 10:* linkdoes the decision maker have control?• A fund manager establishes, markets and manages a

fund according to narrowly defined parameters.• Fund manager:

– has discretion about the assets in which to invest – holds a 10% investment in the fund– receives a market-based fee for its services equal to 1%

of the net asset value of the fund (fees are commensurate with the services provided)

– does not have any obligation to fund losses beyond its 10% investment

– investors do not hold any substantive rights


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Example 11:* linkdoes the manager have control?• Investee: portfolio of fixed rate asset-backed securities,

funded by fixed rate debt instruments + equity instruments.• Equity instruments represent 10% of the value of assets

purchased. • Asset manager is paid fixed and performance-related fees

that are commensurate with the services provided.• Asset manager holds 35% of the equity in the investee

(remaining equity and all the debt instruments are held by a large number of widely dispersed unrelated third-party investors) and manages the active asset portfolio by making investment decisions within parameters.

• Asset manager can be removed, without cause, by a simple majority decision of the other investors.


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Example 12:* linkdoes the investor have control?

• An investment vehicle is created to purchase a portfolio of financial assets, funded by debt and equity instruments issued to a number of investors.

• The equity tranche is designed to absorb the first losses incurred by the portfolio and to receive residual returns of the investment vehicle.

• Investor A holds 35% of the equity tranche and is also the asset manager, managing the vehicle’s asset portfolio within portfolio guidelines. This 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.

• Investor A also receives market-based fixed and performance-related fees for its asset management services.


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Example 13:* linkdoes the manager have control?

• Fund Manager A has a 45% shareholding in Fund B, which it also manages within defined parameters.

• The constitution of the fund defines the fund’s purpose and sets out the investment parameters within which the fund manager can invest. The constitution also requires Fund Manager A to act in the best interests of the shareholders. Within the defined parameters, however, the investment manager (Fund Manager A) has discretion about the assets in which Fund B will invest.

* Refer to Example in the section ‘Agency relationships ’ of the effect analysis for IFRS 10 / IFRS 12

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Examples 14 A–C:* linkfact pattern• A fund manager establishes, markets and manages a

fund and must make decisions in the best interests of all investors (can be removed by simple majority but only for breach of contract).

• Fund manager has wide decision-making discretion. • The fund manager receives a market-based fee for its

services (fixed and performance-related). The fees are commensurate with the services provided.

• Fund manager has extensive decision-making authority to direct the relevant activities of the fund.

* Refer to Example 14 (A, B and C) in paragraph B72 of IFRS 10 Consolidated Financial Statements

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Examples 14 A–C:* linkdoes the fund manager have control?• 14A: fund manager also has 2% in the fund. No

obligation to fund losses beyond investment.• 14B: fund manager also has a more substantial

investment in the fund. No obligation to fund losses beyond investment.

• 14C:– Fund manager has 20% investment.– Fund manager can be removed by board of

directors, who are independent of the fund manager and appointed by the other investors.


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Example 15:* linkdoes the sponsor have control?

Sell asset porfolioServices assets sold

(market fee)Provide first loss

protection

Provide fundingReceive interest from debt instruments

Entitled to any residual returnAbsorbs losses of up to 5% of assets

Manages operation (market fee)Provides credit enhancement and

liquidity facilities


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Judgements and estimatesin applying IFRS 10: summary

• Determining whether control exists requires an assessment of all relevant facts and circumstances, including:

– an evaluation of the purpose and design of the investee;– the activities of the investee;– how decisions about those activities are made; and– rights held by the party involved with the investee.

• Particularly challenging for some structured entities:– relevant activities in those entities are not usually

directed by voting or similar rights – benefits or returns expected from such investments can

be more difficult to assess

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IFRS 12 Disclosure of Interests in Other Entities

• Applies to entities that have an interest in a subsidiary, a joint arrangement, an associate or an unconsolidated structured entity.

• Requires an entity to disclose information that enables users of financial statements to evaluate:

– the nature of, and risks associated with, its interests in other entities; and

– the effects of those interests on its financial position, financial performance and cash flows.

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Main disclosure requirements

• Significant judgements and assumptions made (and changes to those judgements and assumptions) in determining that it has control of another entity

• Information about interest in subsidiaries– composition of the group– interest that non-controlling interests (NCI) have in

activities and cash flows– signficant restrictions– risks– consequences of changes in ownership interest– consequences of losing control

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Subsidiaries that have materialnon-controlling interests

An entity shall disclose for each of its subsidiaries that have NCI that is material to the reporting entity:• name of each of its subsidiaries; • principal place of business; • proportion of ownership held by NCI; • the proportion of voting rights held by NCI;• profit or loss allocated to NCI; • accumulated NCI at the end of reporting period; and • summarised financial information.

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Disclosure of significant restrictions

• Significant restrictions:– acess or use of assets – settlement of liabilities

• Protective rights of NCI that restrict acess/use group assets or settlement of liabilities.

• Carrying amounts in consolidated financial statements of the assets and liabilities to which restrictions apply.

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Disclosure of consolidated structured entities

• Terms of contractual arrangements that could require the parent or its subsidiaries to provide financial support.

• Financial or other support to a consolidated structured entity (without contractual obligation):

– type and amount of support provided; and– reasons for providing the support.

• Financial or other support to a previously unconsolidated structured entity (without contractual obligation) to which such support resulted in control: explanation of relevant factors in reaching decision.

• Current intentions to provide support to a consolidated structured entity.

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Disclosure of changes in parent’s ownership interest

• Without loss of control: schedule that shows the effects on the equity attributable to owners of the parent of any changes in its ownership interest.

• With loss of control during the reporting period:– the portion of that gain or loss attributable to measuring

any investment retained in the former subsidiary at its fair value at the date when control is lost; and

– the line item(s) in profit or loss in which the gain or loss is recognised (if not presented separately).

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Investment entities: exception to consolidation

• Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27), issued in October 2012, introduced an exception to the principle that all subsidiaries shall be consolidated.

• Investment entities measure investments in subsidiaries at fair value through profit or loss (in accordance with IFRS 9 Financial Instruments) instead of consolidating those subsidiaries (except for subsidiaries providing investment-related services).

• Disclosure requirements related to investment entities are in IFRS 12 Disclosure of Interests in Other Entities.

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What is an investment entity?

• An investment entity is an entity that:

a) obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services;

b) commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both; and

c) measures and evaluates the performance of substantially all of its investments on a fair value basis.

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Business purpose of an investment entity

• Purpose = capital appreciation, investment income or both

• It may provide investment-related services (directly or through a subsidiary), to third parties as well as to its investors

– management services/strategic advice and financial support to maximise the investment return (not separate business activity or substantial source of income)

• If a subsidiary provides such services : consolidate• Investment entities hold investment for a limited period

(ie an exit strategy must exist for any investment that can be held indefinitely)

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Typical characteristics of an investment entity

• More than one investment• More than one investor• Unrelated investors• Ownership interests

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Example 16:* investment entitiesis it an investment entity?

• Limited Partnership: formed in 20X1 with a 10-year life.• Offering memo states purpose as to invest in entities

with rapid growth potential with the objective of realising capital appreciation.

• General Partner (GP)=1% of capital; 75 partners (unrelated to GP)=remaining 99% of capital.

• 20X1 → no investment; 20X2 → one controlling interest; 20X3 → investment in five additional companies.

• No other activities other than investing.• Measures and evaluates investments in FV basis.• Plan to dispose of interests.

* Refer to Example 1 in Illustrative Examples that accompany IFRS 10 Consolidated Financial Statements

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• High Technology Fund → invest in technology startup companies for capital appreciation.

• Technology Corporation controls HT Fund (70% interest); remaining 30% owned by 10 unrelated investors.

• TC holds option to acquire investments from HT Fund.

• No plans for exiting investments.• HT Fund is managed by an adviser that acts as

agent for the investors.* Refer to Example 2 in Illustrative Examples that accompany IFRS 10 Consolidated Financial Statements

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• Real Estate Entity → develop, own and operate retail, office and other commercial properties. Typically holds its property in separate wholly-owned subsidiaries.

• Does not have a set time frame for disposing of its property investments.

• Fair value is one performance indicator. Other measures are used (expected cash flows, rental revenues and expenses).

• Real Estate Entity undertakes extensive property and asset management activities. Development activity forms a separate substantial part of Real Estate Entity’s business activities.

* Refer to Example 3 in Illustrative Examples that accompany IFRS 10 Consolidated Financial Statements

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• Annual periods beginning on or after 1 January 2013 (early application permitted)

• Investment entities amendment effective 1 January 2014 (early application permitted)

74Effective date

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Transition relief

• No retrospective adjustment required for entities disposed of in the comparative period(s)

• Requirement to present adjusted comparatives limited to immediately preceding period

• Comparative disclosures relating to unconsolidated structured entities not required when IFRS 12 first applied

ifrs 10 and 12 cpd september 2013

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