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What is control?
IFRS requires that consolidated financial statements
include all entities under a parent's control
[IAS27.12-13(R.05)]. The definition of control and the
concept of preparation of consolidated financial
statements are not based solely on legal ownership.
The definition of control in IFRS, as it relates
to the determination of parent and subsidiary relationships,
is 'the power to govern the financial and operating
policies of an entity so as to obtain benefits from
its activities' [IAS27.4(R.05)].
IAS 27.4(R.05) does not refer to the demonstration or
exercise of control but only to the 'power to control'.
Thus, assertions that a shareholding is passive
because of the parent entity's past behaviour do
not rebut the presumption that it must be consolidated
.
Control is presumed to exist when the parent owns,
directly or indirectly through subsidiaries, more
than one half of an entity's voting power [IAS27.13(R.05)]
.
Control may also exist when a parent owns one half
or less of a subsidiary's voting power . Control
can arise through:
| a) |
an agreement that gives the parent the right
to control the votes of other shareholders [IAS27.13(a)(R.05)]
; |
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| b) |
the power to govern the entity's financial
or operating polices by agreement or statute
[IAS27.13(b)(R.05)] ; |
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| c) |
the right to appoint or remove the majority
of the board of directors or other governing
body or the power to direct
their votes [IAS27.13(c)-(d)(R.05)] ; or |
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| d) |
a combination of factors such that control
rests with the parent . |
An entity may own instruments that, if exercised or converted, give the entity voting power over the financial and operating policies of another entity (potential voting rights). Potential voting rights may take the form of share warrants, share call options, debt or equity instruments that are convertible into ordinary shares. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether an entity has the power to govern the financial and operating policies of another entity. An entity may hold potential voting rights in a company where the majority of ordinary shares is held by a third party. The third party may not be able to consolidate the company if the first entity could obtain control through exercise of the potential voting rights [IAS27.14-15,IG(R.05)] .
The parent will also consolidate special purpose
entities, which may have no legal relationship to
the parent, but are deemed to be under its control
[SIC-12.8-11].
An entity that is controlled by another (the parent)
is included in the parent's consolidated financial
statements [IAS27.12(R.05)].
De facto control
De facto control is a short-hand term that refers to an entity that consolidates another entity because even though it owns less than 50% of the voting shares it is deemed to have control. Control does not arise in this circumstance from potential voting rights, by contract or by other means. Instead, in rare situations, control exists through an entity (the parent) holding and voting a large block of shares in the other entity (the subsidiary) in circumstances where the majority owners of voting shares are believed to be unable to coalesce to successfully vote against the wishes of the parent. The assertion of having de facto control needs to be evaluated against many factors, including the legal and regulatory environment, the nature of the capital market and the ability of the majority owners of voting shares to vote together.
The IASB stated in October 2005 that [IAS 27(R.05)], as written, includes the concept of de facto control
. However, the Board also acknowledged that different treatments as to whether to consolidate based on de facto control might persist. A company that decides to consolidate on the basis of de facto control must define its policy such that the policy can be applied consistently. IAS 27 requires clear disclosure of the basis for consolidating a subsidiary when the parent does not own a majority of the voting rights.
Majority ownership but no control
The presumption of control can be rebutted where
it is demonstrated that ownership of more than one
half of an entity's voting rights does not constitute
control of it [IAS27.13(R.05)] . A majority-owned
entity is not consolidated in the absence of control.
The legal parent may exercise significant influence,
in which case equity accounting is used [IAS28.2,6-7,11,13(R.05)] .
The absence of significant influence or joint control
results in the entity being accounted for as an
investment, in accordance with IAS 39(R.05) [IAS27.31(R.05)].
Exclusions from consolidation
A subsidiary that is acquired, held exclusively
for disposal and meets the definition of an asset
held for sale is not excluded from consolidation.
However, it is measured and accounted for under
IFRS 5 (at fair value less costs to sell) [IAS27.12(R.05)]
[IFRS5.BC53] .
It was common practice under many previous GAAPs to exclude subsidiaries
from consolidation because they were in a dissimilar
line of business. This is prohibited under IFRS
[IAS27.20(R.05)]. Entities may also be considered for
exclusion from consolidation on the grounds that
they are immaterial. The requirements of IFRS do
not apply to immaterial items. However, a change
in the financial circumstances of the group or of
the subsidiary may mean that it becomes material
. A parent should consolidate all
subsidiaries in all periods rather than report changes
in the group's composition from one period to the
next.
What is joint control?
Joint control is the contractually agreed sharing
of control over an economic activity. It exists only
when the strategic financial and operating decisions
require unanimous consent of the controlling parties
[IAS31.3(R.05)]. Joint control is most commonly found over
entities that are formally described as joint ventures,
but can exist in other situations where there is an
agreement providing for the elements of joint control
. Joint control means that no party
to the agreement is entitled to act unilaterally to
control the activity of the entity [IAS31.11(R.05)]. The
parties to the agreement must act together to control
the entity and therefore exercise the joint control
[IAS31.7-12(R.05)]. They account for their interests in
the joint venture using proportionate consolidation,
or using the equity method [IAS31.30,38(R.05)] .
The requirement for a contractual agreement distinguishes
interests that involve joint control from those
where an investor might have significant influence
[IAS31.9(R.05)]. Joint control cannot exist without the
agreement, which might take the form of a contract,
minutes of discussions between the venturers or
appear in the articles of incorporation or by-laws
of the entity subject to the joint control [IAS31.10-12(R.05)]
.
The contractual agreement will usually address:
| a) |
the activity, duration and reporting obligations
of the entity or venture [IAS31.10(a)(R.05)]; |
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| b) |
the appointment of the governing body [IAS31.10(b)(R.05)]; |
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| c) |
the capital contributions required from
the parties [IAS31.10(c)(R.05)]; and |
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| d) |
the sharing of the venture's output, income,
expenses or results [IAS31.10(d)(R.05)]. |
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| e) |
the joint venture's financial and operating
policies [IAS31.12(R.05)]; and |
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| f) |
the delegation of the entity's day-to-day
management, which could be to one of the venturers
or to a third party [IAS31.12(R.05)]; |
The contractual agreement may identify one of the
parties to it as the manager of the day-to-day operations.
The operator does not control the joint venture
but acts within the financial and operating policies
set out in the contractual agreement [IAS31.12(R.05)].
There may be parties to the contractual agreement
who are not part of the exercise of joint control
. These parties are investors and
account for their interests under the equity method
if they are able to exercise significant influence,
or as investments in accordance with IAS 39(R.05) if
they do not.
What is significant influence?
Significant influence is the power to participate
in an entity's financial and operating policy decisions
but not control or jointly control those policies
[IAS28.2(R.05)]. An investor that holds directly or indirectly
20% or more, but less than 50%, of an entity's voting
rights, is presumed to have significant influence.
A shareholding of less than 20% is presumed not
to represent significant influence, unless the influence
can be demonstrated [IAS28.6(R.05)] .
An investor that has significant influence accounts
for its investment using the equity method [IAS28.11,13(R.05)].
Significant influence is usually demonstrated through
the investor's participation in establishing the
entity's financial and operating policies [IAS28.2,6(R.05)].
The investor might show its significant influence
through any of the following:
| a) |
representation on the entity's governing
body [IAS28.7(a)(R.05)]; |
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| b) |
participation in policy-making processes such
as strategic decisions and decisions about dividends
or other distributions [IAS28.7(b)(R.05)]; |
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| c) |
material transactions between the investor
and the entity [IAS28.7(c)(R.05)] ; |
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| d) |
interchange of managerial personnel [IAS28.7(d)(R.05)]
; or |
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| e) |
provision of essential technical information
[IAS28.7(e)(R.05)] . |
Exclusions from equity accounting
An investor might hold more than 20% of an entity
but because of the rights of the other shareholders
or other factors is unable to exercise significant
influence . Such investments are
accounted for under IAS 39(R.05).
IAS 28(R.05) does not apply to investments held by venture capital organisations, mutual funds, unit trusts and similar entities, that are designated at fair value through profit and loss or are classified as held for trading [IAS28.1(R.05)] .
An investment that is classified as held for sale is not accounted for under the equity method.
These investments are accounted for in accordance
with IFRS 5 [IAS28.14(R.05)] .
IFRS allows an investor not to
prepare consolidated financial statements in
certain limited circumstances. Likewise an investor may
not be required to equity account for associates
if all of the following conditions are met [IAS28.13(R.05)].
| a) |
the investor is a wholly-owned subsidiary,
or a partly-owned subsidiary whose owners have
consented to non-application of the equity method; |
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| b) |
the investor's debt or equity instruments
are not traded in a public market, nor is the
investor in the process of issuing debt or equity
in a public market; and |
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| c) |
a parent of the investor produces publicly
available IFRS consolidated financial statements.
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An investor that does not apply the equity method
accounts for associates in accordance with IAS 39(R.05)
[IAS28.35(R.05)], [IAS27.37(R.05)] .
Presentation and Disclosure
See 'Consolidated financial statements' for the presentation and disclosure
requirements for group financial statements, including
subsidiaries, joint ventures and associates.
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