4 AGR 2024 Group (parent, subsidiaries) IFRS 10 PDF

ACCOUNTABILITY GOVERNANCE AND REGULATION II Consolidation and IFRS 10 (groups obliged and exempted, control) Chiara Saccon Venice, 2024 4  Programme and study materials Accounting Regulation (sli...

ACCOUNTABILITY GOVERNANCE AND REGULATION II Consolidation and IFRS 10 (groups obliged and exempted, control) Chiara Saccon Venice, 2024 4  Programme and study materials Accounting Regulation (slides and Leuz article) TEXTBOOK: IFRS regulation – Chapter 2 IFRS: an overview Consolidation according to theories (slides) IFRS Consolidation: when to consolidate – Chapter 4 Consolidated financial statements IFRS Consolidation: how to consolidate IFRS Consolidation: how to consolidate – Chapter 3 Meaning of consolidation – Chapter 5 Combining individual financial statem. – Chapter 6 More on consolidation accounting  Consolidation Accounting for Subsidiaries IFRS Regulation The importance of consolidated financial report is recognized in IFRS regulation According to IFRS every group of entities shall present the consolidated financial report IFRS 10 is the principal standard (part of a Consolidation Package: IFRS 10, 11 and 12 dated 2011) and deals with the situation in which the investor has control over the investee  IFRS Regulation Main accounting standards within IFRS dealing with the issue of consolidation are: IFRS 10 – Consolidated Financial Statements IFRS 3 – Business Combinations IAS 28 – Investments in Associates IFRS 11 – Joint arrangements IAS 27 - Separate Financial Statements  IFRS Regulation The objective of IFRS 10 is to establish principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities. To meet the objective IFRS 10: – requires an entity (the parent) that controls one or more other entities (subsidiaries) to present consolidated financial statements; – defines the principle of control, and establishes control as the basis for consolidation; – sets out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee  When to consolidate Issues: Understanding when we are dealing with a group of companies is not always straightforward Deciding whether an entity belongs to a group requires a careful judgment But the majority of companies belong to groups and consolidated report is the only appropriate way to illustrate  Fundamentals in IFRS regulation Close connection between the notion of control and the notion of group A group exists when an entity controls another entity In a group the controlling entity shall prepare the consolidated report All entities in a group continue to exist as separate entities  IFRS Regulation Important issues: Group definition Parent entities obliged to present consolidated reports Parent entities exempted Subsidiaries definition through control Subsidiaries excluded  IFRS Regulation International regulation: Group definition (given) Parent entities obliged to present consolidated reports (all) Parent entities exempted (when group reports exist) Subsidiaries definition through control (form vs substance) Subsidiaries excluded (forbidden)  IFRS Regulation IFRS 10 - Parent exception IFRS 10 applies to all entities, except as follows: (a) a parent need not present consolidated financial statements if it meets all the following conditions: (i) 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 consolidated financial statements; (ii) its debt or equity instruments are not traded in a public market  IFRS Regulation (IFRS 10 - Parent exception) (iii) it did not file, nor is it 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 (iv) its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with IFRSs. ➔ exemptions based on existing consolidated financial reports ➔ no exemption for small groups in IFRS regulation  IFRS Regulation Control in general Centrality of the control concept Different ways of controlling (majority of shares, contractual agreements, claims..) Principles-based / rules-based approaches Substance over form principle / legal principle Proprietary view / entity view Broad definition could be: Power to govern the financial and operating policies of that entity so as to obtain benefits from its activities  IFRS Regulation IFRS 10 - Principle of control IFRS 10 defines the principle of control, and establishes control as the basis for consolidation An investor, regardless of the nature of its involvement with an entity (the investee), shall determine whether it is a parent by assessing whether it controls the investee 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.  IFRS Regulation IFRS 10 - Principle of control Thus, an investor controls an investee if and only if the investor has all the following: (a) power over the investee; (b) exposure, or rights, to variable returns from its involvement with the investee and (c) the ability to use its power over the investee to affect the amount of the investor’s returns. ➔ Simultaneous fullfillment ➔ Principles-based /substance –over-form control concept  IFRS 10 - Elements of control: power An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities Relevant activities “significantly affect the investee’s returns”. They include (eg): – Selling and purchasing of goods and services – Managing financial assets during their life – Selecting, acquiring or disposing of assets – Researching and developing new products or processes – Determining a funding structure or obtaining funding  IFRS 10 - Elements of control: power Power arises from rights over the investee (from which the ability to direct relevant activities arises). Assessing power could be: – straightforward when power over an investee is obtained directly and solely from the voting rights granted by equity instruments such as shares, and can be assessed by considering the voting rights from those shareholdings – more complex and require more than one factor to be considered, for example when power results from one or more contractual arrangements  IFRS 10 - Elements of control: power Example of rights giving power include (eg): – Voting rights (or potential voting rights) – Rights to appoint, reassign or remove members of an investee’s key management personnel who have the ability to direct the relevant activities – Rights to appoint or remove another entity that directs the relevant activities – Rights to direct the investee to enter into, or veto any changes to, transactions for the benefit of the investor – Other rights that give the holder the ability to direct the relevant activities (eg. decision making rights specified in a management contract)  IFRS 10 - Elements of control: power Rights must be substantive rights – the holder can actually exercise (no obstacles) – are exercitable when the decision over the relevant activities need to be taken Assessing substantive rights needs judgment and case by case analysis No power if investor has only protective (defensive) rights  IFRS 10 - Elements of control: 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  IFRS 10 - Elements of control: links between power and returns An investor controls an investee if the investor not only has power over the investee and exposure or rights to variable returns from its involvement with the investee, but also has the ability to use its power to affect the investor’s returns from its involvement with the investee Thus, an investor with decision-making rights shall determine whether it is a principal or an agent. An investor that is an agent does not control an investee when it exercises decision-making rights delegated to it  IFRS 10 - Control An investor shall consider all facts and circumstances when assessing whether it controls an investee The investor shall reassess whether it controls an investee if facts and circumstances indicate that there are changes to one or more of the three elements of control  IFRS Regulation Controlled entities exclusions (from a consolidated report which is produced) No excluded entities allowed be careful: in your textbook (p. 105-106) there is confusion between: – exemptions of groups from the preparation of consolidated report (not prepared) and – exclusion of controlled entities from the consolidated report (that is prepared)  IFRS regulation Investment in other entities, various situations: If control: consolidated financial statements If significant influence (20-50%): equity method If not control nor significant influence but simple investment (