EU Accounting Rule 2: Consolidation and Accounting for Joint Arrangements and Associates PDF
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Summary
This document outlines the EU Accounting Rule 2, focusing on consolidation and accounting for joint arrangements and associates. It provides detailed information about objectives, scope, definitions, consolidation procedures, and disclosures.
Full Transcript
**EUROPEAN UNION** **ACCOUNTING RULE 2** **CONSOLIDATION AND ACCOUNTING FOR JOINT ARRANGEMENTS AND ASSOCIATES** **I N D E X** 1\. Objective 5 2\. Scope 5 3\. Definitions 5 4\. Scope of Consolidation 7 4.1 General 7 4.2 Exclusive Control 8 4.2.1 General 8 4.2.2 Power indicators 8 4.2.3 Be...
**EUROPEAN UNION** **ACCOUNTING RULE 2** **CONSOLIDATION AND ACCOUNTING FOR JOINT ARRANGEMENTS AND ASSOCIATES** **I N D E X** 1\. Objective 5 2\. Scope 5 3\. Definitions 5 4\. Scope of Consolidation 7 4.1 General 7 4.2 Exclusive Control 8 4.2.1 General 8 4.2.2 Power indicators 8 4.2.3 Benefits indicators 10 4.2.4 Delegated power 11 4.2.5 Control indicators specific to EU entities 11 4.3 Joint Control 13 4.3.1 General 13 4.3.2 Joint arrangement indicators 13 4.3.3 Types of joint arrangement 13 4.4 Significant Influence 15 4.4.1 General 15 4.4.2 Indicators of significant influence 15 4.5 Investment entities: Fair Value Requirement 16 4.5.1 Definition of an investment entity 16 4.5.2 Investment entity interests in controlled entities 16 4.5.3 Investment entity interests in associates and joint ventures 16 4.6 Interests in structured entities 17 4.7 Materiality 18 4.8 Other investments 18 4.9 Contributions from owners / quasi capital contributions 18 5\. Consolidation Procedures 19 5.1 General comments and methods 19 5.2 Controlled entities 19 5.2.1 Measurement/global consolidation 19 5.2.2 Inter-entity elimination/elimination of inter-entity transactions and balances 19 5.2.3 Goodwill or negative goodwill accounting/minority interests 20 5.3 Joint operations 20 5.4 Associates and joint ventures 21 5.4.1 Application of equity method 21 5.4.2 Equity method procedures 21 5.4.3 Transactions between an investor and its associate/joint venture 21 5.4.4 Impairment losses 22 6\. Derecognition 22 6.1 Controlled entities 22 6.2 Associates and joint ventures accounted for using the equity method 22 7\. Disclosures 23 7.1 Controlled entities 23 7.1.1 Significant judgements and assumptions 23 7.1.2 Listing of consolidated entities 23 7.1.3 Nature and extent of significant restrictions 23 7.1.4 Nature of risk associated with interest in consolidated structured entities 24 7.1.5 Consolidation procedures 24 7.1.6 Changes in a controlling entity\'s ownership interest in a controlled entity 24 7.2 Joint arrangements and associates 25 7.2.1 Significant judgements and assumptions 25 7.2.2 Listing of significant associates and joint arrangements 25 7.2.3 Summarised financial information for associates and joint ventures 25 7.2.4 Application of equity method to interests in associates and joint ventures 26 7.2.5 Significant restrictions on funds transfers 26 7.2.6 Risks associated with interests in associates and joint ventures 26 7.3 Interests in unconsolidated controlled entities (investment entities) 27 7.4 Interests in structured entities that are not consolidated 27 7.4.1 Nature of interests 27 7.4.2 Nature of risks 28 7.5 Non-quantifiable ownership interests 28 7.6 Controlling interests acquired with the intention of disposal 28 8\. Effective date 29 9\. Reference to other rules 29 Appendix 30 A. Decision tree concerning the different types of control 30 B. Type of control and type of entity 31 Objective ========= The objective of this accounting rule is to define the economic entity in the European Union (EU) context, controlled entities, jointly controlled entities and associates, to identify the circumstances in which they should be consolidated and how they should be included in the consolidated accounts. This accounting rule also requires certain information to be disclosed about interests in controlled entities, joint arrangements, associates and structured entities in the notes to the financial statements. Scope ===== This accounting rule applies to accounting for controlled entities, jointly controlled entities and associates in the consolidated financial statements of the EU and those EU entities which prepare and publish separately their financial statements and have interests in other entities. This accounting rule establishes requirements for the preparation and presentation of consolidated financial statements by EU entities having interests in other entities. This accounting rule excludes the following issues: - - - - Definitions =========== The following terms are used in this accounting rule with the meanings specified: 1. **Associate** is an entity over which the investor has significant influence. 2. **Benefits** are the advantages an entity obtains from its involvement with other entities. Benefits may be financial or non-financial. The actual impact of an entity involvement with another entity can have positive and negative aspects. 3. **Binding arrangement** is an arrangement that confers enforceable rights and obligations on the parties to it as if it were in the form of a contract. It includes rights from contracts or other legal rights. 4. **Consolidated financial statements** are the financial statements of an economic entity in which assets, liabilities, net assets/equity, revenue, expense and cash flows of the controlling entity and its controlled entities are presented as those of a single entity. 5. **Reporting date** means the date of the last day of the reporting period to which the financial statements relate. 6. **Control:** An entity controls another entity when the entity is exposed, or has rights, to variable benefits from its involvement with the other entity and has ability to affect the nature or amount of those benefits through its power over the entity. 7. **A controlled entity** is an entity that is under the control of another entity (known as the controlling entity). 8. **A controlling entity** is an entity that has one or more controlled entities. 9. **An economic entity** means a group of entities comprising a controlling entity and one or more controlled entities. 10. The **scope of consolidation** is the identification of all entities to be consolidated. This assessment depends on the nature of the control between the controlling entity and the other entity as well as on other requirements that are explained in this accounting rule. 11. **Global consolidation** means that the financial statements of the controlling entity and their controlled entities are combined on a line-by-line basis by adding together like items of assets, liabilities, capital, revenue and expenses. 12. **A non-controlling interest** is that part of the net assets/capital of a controlled entity not attributable, directly or indirectly through controlled entities, to the controlling entity. 13. **Goodwill** is the difference between the acquisition cost of the investment and the acquirer\'s interest in the net value of the identifiable assets, liabilities and contingent liabilities at the date of the acquisition. Goodwill represents a payment made by the acquirer in anticipation of future economic benefits from assets that cannot be individually identified and separately recognised. 14. **Significant influence** is the power to participate in the financial and operating policy decisions of another entity but is not control or joint control of those policies. 15. **Equity method** is a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor\'s share of capital of the investee\'s net assets/equity of the associate or joint venture. 16. An **interest in another** **entity** refers to involvement by way of binding arrangements or otherwise that exposes an entity to *variability of benefits* from the performance of the other entity. An interest in another entity can be evidenced by, but is not limited to, the holding of equity or debt instrument as well as other forms involvement such as the provision of funding, liquidity support, credit enhancement, and guarantees. It includes the means by which the entity has control or joint control of, or significant influence over, another entity. The entity does not necessarily have an interest in another entity solely because of a typical funder/recipient or customer/supplier relationship. 17. **Joint control** is the agreed sharing of control of an arrangement by way of a binding arrangement, which exists only when decisions about the relevant activities require the unanimous consent of parties sharing control. 18. **Joint arrangement** is an arrangement of which two or more parties have joint control. 19. **Joint operation** is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. 20. **Joint venture** is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. 21. **A joint operator** is a party to a joint operation that has joint control of that joint operation. 22. **A** **joint** **venturer** is a party to a joint venture that has joint control of that joint venture. 23. **Power** consists of existing rights that give the current ability to direct the relevant activities of another entity. 24. **Protective rights** are rights designed to protect the interests of the party holding those rights without giving that party power over the entity to which those rights relate. 25. **Relevant activities:** For the purpose of this accounting rule, relevant activities are activities of the potentially controlled entity that significantly affect the nature or amount of the benefits that an entity receives from its involvement with that other entity. 26. **A** **separate vehicle** is a separately identifiable financial structure, including separate legal entities or entities recognised by statute; regardless of whether those entities have a legal personality. 27. **A structured entity** is: 28. **Contributions from owner**s are inflows of resources to an entity, contributed by external parties in their capacity as owners, which establish or increase an interest in the net financial position of the entity. Scope of Consolidation ====================== General ------- 1. The consolidated financial statements are being prepared to present the financial situation of an **\"economic entity\"** meaning a group of entities comprising a controlling entity and one or more controlled entities. Regarding the EU consolidated financial statements; they comprise financial information regarding the EU reporting entity and its controlled entities. 2. A controlling entity, which issues consolidated financial statements, should consolidate all controlled entities, foreign and domestic. The first step of consolidation is therefore to determine the scope of consolidation, which means the identification of all entities to be consolidated. The determination of the scope of consolidation shall take into account the general principle of materiality. 3. In order to determine the scope of consolidation in the EU consolidated financial statements, this accounting rule applies the \"control concept\". The definition and indicators of control are provided further in the section 4.2 of this accounting rule. 4. In case it is assessed that the EU entity does not have an exclusive control over another entity, it should further consider whether it has joint control of and significant influence over an entity following guidance provided in sections 4.3 and 4.4 of this accounting rule. 5. The decision regarding the most appropriate method of accounting for interests in other entity depends on the type of control that the entity has over the other entity, i.e. exclusive control, joint control, significant influence. - A decision flow chart concerning the different types of control can be found in the [appendix A]. Exclusive Control ----------------- ### General An entity controls another entity when it is exposed, or has rights, to variable benefits from its involvement with the other entity and has the ability to affect the nature and amount of those benefits through its power over the other entity. Thus, an entity controls another entity if and only if the entity has all the following: a. Power over the other entity; b. Exposure or rights to variable benefits from its involvement in other entity; and c. An EU entity shall consider all facts and circumstances when assessing whether it controls another entity. Indeed, it is necessary to identify the existence of a power element such as the power to govern the relevant policies of another entity and a benefit element, which represents the ability of the controlling entity to use its power over the other entity to benefit from the activities of the other entity. For instance, control does not necessarily require an entity to hold a majority shareholding or other equity interest in the other entity. The determination of the type of control includes an element of judgment; EU entity shall make an overall assessment of the situation (considering all indicators) to determine whether control exists and not only consider each indicator in isolation. ### Power indicators An entity has power over another entity when the entity has existing rights that give it the current ability to direct *the relevant activities*, i.e. the activities that significantly affect the nature or amount of the benefits from its involvement with the other entity. For many entities, a range of operating and financing activities significantly affect the benefits they generate. Any activity that assists in achieving or furthering the objectives of a controlled entity may affect the benefits to the controlling entity. Examples of activities that, depending on the circumstances, can be *relevant activities* include, but are not limited to: a. Using assets and incurring liabilities to provide services to service recipients; b. Distributing funds to specified individuals or groups; c. Collecting revenue through non-exchange transactions; d. Selling and purchasing of goods or services; e. Managing physical assets; f. Managing financial assets during their life (including upon default); g. Selecting, acquiring or disposing of assets; h. Managing a portfolio of liabilities; i. Researching and developing new products or processes; and j. Determining a funding structure or obtaining funding. If two or more entities each have existing rights that give them the unilateral ability to direct different relevant activities, the entity that has the current ability to direct the activities that most significantly affect the nature or amount of benefits from that entity has power over that other entity. Power arises from rights such as: voting rights granted by equity instruments or rights conferred by binding arrangements. The power must be *presently exercisable*. However, in case of an entity established with predetermined activities, the right to direct the relevant activities may have been exercised at the time that the entity was established. An entity can have power over another entity even if it does not have responsibility for the day to day operation of the other entity. *The existence of rights over another entity does not necessarily give rise to power for the purpose of this accounting rule. An entity does not have power over another entity solely due to the existence of regulatory control (i.e. the power of the legislature to establish the regulatory framework within which entities operate and to impose conditions or sanctions on their operations;* such power does not constitute control of the assets deployed by these entities*) or due to economic dependence (e.g. when a profit orientated entity that is economically dependent on business with the EU entity and as such the EU entity have some power as a purchaser but does not control the entity\'s financial and operating operations).* *The existence of statutory powers to operate independently does not, of itself, preclude an entity from having the ability to direct the operating and financial policies of another entity with statutory powers so as to obtain benefits.* The following examples illustrate indicators of power that an entity may have over another entity: a. b. c. d. e. *The entity has the ability to veto operating and capital expenditure budgets of the other entity;* f. *The entity has the ability to veto, overrule, or modify governing body decisions of the other entity;* g. *The entity has the ability to approve the hiring, reassignment and removal of key personnel of the other entity; or* h. *The mandate of the other entity is established and limited by legislation.* ### Benefits indicators *An entity is exposed to variable benefits from its involvement in other entity when the benefits it seeks from its involvement have the potential to vary as a result of the other entity\'s performance. Although an entity getting involved in another entity expects positive benefits, the actual impact of an entity involvement with another entity can have positive or negative aspects.* *Benefits may be financial or non-financial. Financial benefits include returns on investment such as dividends or similar distributions, while non-financial benefits include economic benefits received directly by service recipients of the entity (service potential). Non-financial benefits can occur when the activities of another entity are in agreement with the objectives of the entity and support the entity in achieving its objectives (e.g. in case of the decentralised EU agencies which carry out technical, scientific or managerial tasks that help the EU institutions make and implement the EU policies).* *An entity controls another entity only if the entity has the ability to use its power to affect the nature or amount of the benefits from its involvement in the other entity. As such existence of compatible objectives is insufficient for an entity to conclude that it controls another entity, unless the entity has ability to direct the other entity to pursue its objectives.* The following examples illustrate benefits that an entity may receive from its involvement with another entity: a. b. c. d. e. f. g. h. *The entity is able to benefit from specialised knowledge of another entity;* i. *The entity expects higher level of service quality than would otherwise be the case.* ### Delegated power An entity with decision-making rights shall determine whether it is a principal or an agent. An entity shall also determine whether another entity with decision-making rights is acting as **an agent** for the entity. An agent is a party primary engaged to act on behalf and for the benefit of another party or parties (**the principal(s)**) and therefore does not control the other entity when it exercises its decision making authority. Thus, sometime a principal\'s power may be held and exercisable by an agent, but on behalf of the principal. When assessing whether it controls another entity, the EU entity shall treat the decision making rights delegated to its agent as held by the entity directly. Unless a single party holds substantive rights to remove the decision maker and can remove the decision maker without cause, determining whether a decision maker is an agent requires evaluation of the following factors: a. b. c. d. Different weightings shall be applied to each of the factors on the basis of particular facts and circumstances. ### Control indicators specific to EU entities 1. The most common control indicator -- the majority of voting rights -- is in most cases not applicable for the EU, as there are normally no capital links between entities. Therefore other power and benefits indicators are usually more relevant to assess levels of control. The most common control indicators within the EU are: creation of an entity through founding treaties or secondary legislation; financing of an entity from the EU budget; the existence of voting rights within governing bodies; an audit by the European Court of Auditors; and discharge by the European Parliament. Nevertheless, all facts and circumstances should be considered while assessing the control criteria. 2. Within this context it is noted that the Art 141 of the Financial Regulation[^1^](#fn1){#fnref1.footnote-ref} (FR) requires that the EU consolidated financial statements include the financial statements of the institutions financed by the EU budget and of the bodies set up by EU under the TFEU and the Euratom Treaty, which have legal personality and which receive EU budget contributions (i.e. bodies according to art. 208 FR). Indeed consolidation of these entities (the institutions/advisory bodies, the decentralised and executive agencies and other EU bodies) is also in compliance with the concept of control, as defined in this accounting rule, as the criteria are met. In particular: - the Institutions have been created through their founding treaties (including modifications of their structure/statutes). They represent the basis of the EU organisational structure and contribute incontestably to the EU\'s objectives. The EU institutions (except for the European Central Bank (ECB)) receive financing from the general budget and are part of the discharge procedure. The ECB is fully independent from other EU institutions, is not audited by the Court of Auditors, nor does it undergo the discharge procedure by the European Parliament; and as such is not under control of the EU or is within the scope of consolidation. - the agencies, as they have been created through an act of secondary legislation, which in most cases includes a Council decision. These decisions stipulate precisely the nature and scope of the agencies\' activities; their contribution to the EU objectives; procedures on how to execute activities; as well as a description of their organisational structure. 3. Furthermore, art. 141 of the FR also stipulates that other entities shall be included within the scope of consolidation if the control criteria, indicated in this accounting rule, is met. If, on the basis of analysis of the control indicators, the entity is considered to be under EU entity control, its financial statements are consolidated into the EU consolidated financial statement. 4. The decision tree regarding the consolidation of entities in the EU consolidated financial statements is included below: Yes No Yes No Joint Control ------------- ### General The following characteristics are common to all joint arrangements: - - **Joint control** is sharing of control of an arrangement, which exists only when decisions about the relevant activities require the *unanimous consent* of the parties sharing control. A party with joint control of an arrangement can prevent any other parties, or group of the parties, from controlling the arrangement. An arrangement can be a joint arrangement even though not all of its parties have joint control of the arrangement. This accounting rule distinguishes between parties that have joint control of an arrangement (joint operators or joint venturers) and other parties that only participate in the joint arrangement without having joint control. ### Joint arrangement indicators An arrangement, that confers similar rights and obligations on the parties, may be evidenced in a number of ways, for example by a contract between the venturers or minutes of discussions. In some cases, the arrangement is incorporated in the governing legislation, articles or other by-laws of the joint venture. Whatever its form, the arrangement is usually in writing and deals with such matters as: - - - - - The sharing by the parties to the joint arrangement of the assets, liabilities, revenue, expenses, economic result of the year, or cash flows of the joint arrangement. ### Types of joint arrangement Two types of joint arrangements are identified on the basis of the rights and obligation of the parties to the joint arrangement: **A joint operation** is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. **A joint venture** is a joint arrangement whereby the parties that have joint control of the arrangement have rights to *the net assets* of the arrangement. When reporting an interest in a joint arrangement in consolidated financial statements, it is essential that a joint venturer or joint operator record the substance and economic reality of the arrangement, rather than the joint arrangement\'s particular structure or form. Therefore, an entity shall determine the type of joint arrangement in which it is involved by considering its rights and obligations arising from the arrangement. In assessing its rights and obligation, the following should be considered: - Structure of the joint arrangement, and Only when the joint arrangement is structured through a separate vehicle: - Legal form of the separate vehicle; - The terms of the arrangement agreed by the parties or established by legislative or executive authority, and, - When relevant, other facts and circumstances. [Joint arrangements not structured through a separate vehicle] A joint arrangement that is not structured through a separate vehicle is always classified as **a joint operation**. The operation of some joint arrangements involves the use of the assets and other resources of the parties rather than the establishment of a corporation, partnership or other entity, or a financial structure that is separate from the parties to the joint arrangement. In such cases, the binding arrangement establishes the parties\' rights to the assets and obligations for the liabilities, relating to the arrangement and the parties\' rights to the corresponding revenues and obligations for the corresponding expenses. For example, two joint operators combine their operations, resources and expertise in order to produce and sell a particular product, e.g. an aircraft. Each venturer bears its own costs and takes a share of the revenue from the sale of the aircraft. Similarly, some joint arrangements involve the joint control, and often the joint ownership, by the joint operators of one or more assets contributed to, or acquired for the purpose of, the joint arrangement and dedicated to the purposes of the joint arrangement. The assets are used to obtain benefits for the joint operators. Each joint operator may take a share of the output from the assets and each bears an agreed share of the expenses incurred. [Joint arrangements structured through a separate vehicle] A joint arrangement in which the assets and liabilities relating to the arrangement are held in a separate vehicle can be **either a joint venture or a joint operation**. When the parties have structured a joint arrangement in a separate vehicle, the parties need to assess whether the legal form of the separate vehicle, the terms of the binding arrangement and, when relevant, any other facts and circumstances give them rights to assets and obligation for the liabilities, relating to the arrangement (i.e. the arrangement is a joint operation) or rights to the net assets of the arrangement (i.e. the arrangement is a joint venture). In many cases, a joint arrangement involves the establishment of a corporation, partnership or other entity in which each joint venturer has an interest. The entity operates in the same way as other entities, except that a binding arrangement between the joint venturers establishes joint control over the activity of the entity. A joint venture controls the assets of the joint arrangement, incurs liabilities and expenses and earns revenue. It acts with a separate legal personality, may enter into contracts in its own name and raise finance for the purposes of the joint venture activity. Each joint venturer is entitled to the share of the surplus of the jointly controlled entity. In such cases the joint arrangement is classified as **a joint venture**. However, in some cases either legal form of the separate vehicle does not confer separation between the parties and the separate vehicle (i.e. the assets and liabilities held in the separate vehicle are the parties\' assets and liabilities) or the right and obligations of the parties presumed by the legal form are modified in the binding arrangement (e.g. the binding arrangement stipulates that parties have rights of the assets and are liable for the liabilities of an incorporated entity). Furthermore, other facts and circumstances may indicate that in substance parties have rights to assets and obligation for liabilities (e.g. when the activities of an arrangement are primarily designed for the provision of output to the parties and the controlled entity is prevented from selling its output to the third parties; then also the liabilities incurred by the arrangement are satisfied by the cash flows received from the parties). In these cases, even if the joint arrangement is structured through a separate vehicle, it may satisfy the definition of **a joint operation**. Significant Influence --------------------- ### General 1. Significant influence is the power to participate in the financial and operating policy decisions of the investee, but it is not exclusive control or joint control over those policies. 2. An investment should be accounted for in the consolidated financial statements when the EU entity has significant influence over another entity and where the investment leads to a holding of a quantifiable ownership rights. 3. Quantifiable ownership interests can be in the form of shareholding or other formal equity structure of another entity (shares, units in property trust) or in another form in which the entity\'s interests can be measured reliably (e.g. interests in partnership). ### Indicators of significant influence 1. The judgment for the nature of control is based on presumptions and is usually evidenced in one or more of the following ways: - - - - - 2. If the entity has ownership interest is in the form of shareholding (or other quantifiable interests) and it holds, directly or indirectly through controlled entities, 20% or more of the voting power of another entity, it is presumed that the entity does have significant influence, unless it can be demonstrated that this is not the case. 3. The existence of potential voting rights (as share warrants, share call options, debt or equity instruments that are convertible into ordinary shares) that are currently exercisable or convertible should be also taken into account while assessing the significant influence. 4. Nevertheless, the determination of significant influence over an entity is a matter of judgment concerning the nature of the relationship between the investor and the other entity. Investment entities: Fair Value Requirement ------------------------------------------- ### Definition of an investment entity An **investment entity** is an entity that: \(a) Obtains funds from one or more investors for the purpose of providing those investors with investment management services; \(b) Has the purpose of investing funds solely for returns from capital appreciation, investment revenue, or both, (c)Measures and evaluates the performance of substantially all of its investments on a fair value basis. ### Investment entity interests in controlled entities An investment entity shall not consolidate its controlled entities. Instead, an investment entity shall measure an investment at fair value in accordance with the EU accounting rule 11 \"Financial Instruments\". In case an investment entity has interests in other entity that is not itself an investment entity and whose main purpose is providing service-related activities (e.g. investment advisory services) to the investment entity; it shall consolidate this entity. A controlling entity of an investment entity that is not itself an investment entity shall present consolidated financial statements in which it measures the investments of a controlled investment entity in accordance with the EU accounting rule 11 and consolidates the other assets and liabilities and revenue and expenses of the controlled investment entity. In considering whether investment entity criteria are met in the EU context, one needs to look at the substance over the form. The fact that there are no capital links between an EU entity and the investment entity does not preclude from applying the accounting treatment described in this section to investments made by the investment entity on behalf of the EU. ### Investment entity interests in associates and joint ventures An investment entity shall account for investments in associates and joint ventures at fair value through surplus or deficit. An EU entity, having interest in an associate or joint venture which meets the definition of an investment entity, shall when applying the equity method retain the fair value measurement by that entity to its interest in controlled entities. Furthermore, when an EU entity has an investment in an associate, portion of which is held indirectly through an investment entity, the EU entity shall measure that portion of the investment at fair value through surplus or deficit in accordance with the EU accounting rule 11 \"Financial Instruments\". The same applies in the situation, when the investment in an associate or joint venture is held by, or is held indirectly through, an entity that is a venture capital organization, or mutual fund, unit trust and similar entities. In these cases the EU entity shall measure the investment in accordance with the EU accounting rule 11. Similarly, the EU entity shall retain the fair value measurement of the portion of the investment which is held through a venture capital organization, or mutual fund, unit trust and similar entities. Interests in structured entities -------------------------------- A **structured entity** is an entity that has been designed so that the conventional ways in which an entity is controlled are not the dominant factors in deciding who controls the entity. In the case of entities (such as EU agencies and bodies) where administrative arrangements or legislation are often the dominant factors in deciding who has control of an entity, a structured entity is an entity that has been designed so that administrative arrangements or legislation are not the dominant factor in deciding who controls the entity. In the case of entities where voting or similar rights are normally the dominant factor in deciding who has control of an entity (which may be the case for some entities with profit objectives), a structured entity is an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity. Although *binding arrangements* frequently occur between public sector entities, binding arrangements are not normally the dominant factor in determining who controls an entity. Therefore the use of binding arrangements to determine the relevant activities of an entity may indicate the existence of a structured entity. Depending on the context a structured entity could be (i) an entity for which most of the activities are predetermined, with the relevant activities limited in scope but directed through binding arrangements or (ii) an entity for which any voting rights relate to administrative tasks only and the relevant activities are directed by means of binding arrangements. A structured entity often has some or all of the following features or attributes: - *Restricted activities.* - A narrow and well-defined objective, such as to carry out research and development activities, provide a source of capital or funding to an entity or provide investment opportunities for investors by passing on risks and rewards associated with the assets of the structured entity to investors. - Insufficient net assets/equity to permit the structured entity to finance its activities without subordinated financial support. - Financing in the form of multiple contractually linked instruments to investors that create concentrations of credit or other risks (tranches). Examples of entities that are regarded as structured entities include, but are not limited to: a partnership between an EU entity and a private sector entity that is not a joint venture, being a partnership established and directed by binding arrangements, securitization vehicles, asset-backed financings or some investment funds. The mere fact that an EU entity provides funding to another entity does not make that entity a structured entity. Nor is an entity that is controlled by voting rights a structured entity simply because, for example, it receives funding from third parties following a restructuring. The EU entity applies the control criteria to its interests in the structured entity in accordance with this accounting rule. If the structured entity is not under control of the EU entity, the EU entity provides additional disclosures with regard to its interests in the structured entity as listed in chapter 7.4 below. Materiality ----------- As already mentioned in chapter 4.1, an entity could be excluded from the scope of consolidation by applying the principle of materiality, the reason for this is that its non-consolidation would not influence the economic decisions of users of the financial statements. Other investments ----------------- When the entity has neither control nor significant influence, the investments must be recorded by applying the EU accounting rule 11 \"Financial Instruments\". The European Commission has several minority investments in investment funds. In most of the cases, the European Commission holds stakes between 15% and 25%. The EU do not participate in the financial and operating policy decisions of these investment funds. Consequently, they have to be valued according to the EU accounting rule 11. Contributions from owners / quasi capital contributions ------------------------------------------------------- 1. In considering whether the entity (controlled entity, joint venture, associate) received contribution from owners or non-exchange transactions (EU accounting rule 17 \"Revenue from non-exchange transactions (taxes and transfers)\"), it should take into account the *substance of the transaction*. Sometimes Council Regulations establishing an entity (in which the EU body is a venturer or partner in an associate) include a paragraph that contributions from the EU form the source of revenue of the entity. From an accounting point of view and with regard to *the faithful representation* principle (EU accounting rule 1 \"Financial Statements\") these contributions are contributions from owners. For consolidation purposes these contributions can be seen as quasi capital contributions (or quasi equity). For example, if a transaction purports to be a pre-financing, but forms the underlying funding of the entity according to a Council Regulation, and voting rights within the entities management board are linked to the contributions, the transaction has clearly the form of contribution from owners or quasi capital contributions. Owner means in this context not owner in the sense of owning shares of an entity but rather the party (i.e. EU entity) that has political interest in the entity. 2. Contributions from owner may also be evidenced by: - - - 3. If the substance is clearly that of a loan, donation or other kind of liability, or revenue, the transaction shall be treated as such under the adequate EU accounting rule. For example, if a transaction purports to be a contribution from owners, but specifies that the reporting entity will pay fixed distributions to the transferor, with a return of the transferor\'s investment at a specified future time, the transaction has more characteristics of a loan and therefore the EU accounting rule 11 \"Financial Instruments\" would be applicable. Consolidation Procedures ======================== General comments and methods ---------------------------- 1. Having determined the scope of consolidation, the second part of the consolidation consists in the different consolidation procedures to be executed. The graphic in [appendix B] shows that the type of control/type of entity determines the consolidation procedure that must be applied. 2. All consolidation procedures require first of all a harmonisation of the financial statements of each consolidated entity. The financial statements of each controlled entity, associate or joint venture should be prepared using uniform accounting policies for like transactions and other events in similar circumstances. If it is not practical to use uniform accounting policies in preparing the consolidated financial statements, that fact should be disclosed together with the proportion of the items in the consolidated financial statements to which the different accounting policies have been applied. 3. To this effect, article 152 of the FR stipulates that all institutions and, \"all bodies according to article 141\" should apply the same accounting rules and methods, adopted by the Commission\'s accounting officer. In addition, the institutions and, \"bodies according to article 141\" have to apply the same harmonised chart of accounts. 4. The most recent available financial statements of a controlled entity, associate or joint venture shall be used by the EU entity when preparing its consolidated financial statements. When the financial statements used in the consolidation are drawn up at different reporting dates, adjustments should be made for the effects of significant transactions or other material events that occur between those dates and the date of the controlling entity's financial statements. Controlled entities ------------------- ### Measurement/global consolidation Global consolidation means that the financial statements of the reporting entity and its controlled entities are combined on a line-by-line basis by adding together like items of assets, liabilities, capital, revenue and expenses. This method is also the most relevant procedure for the consolidation of the EU institutions and bodies. ### Inter-entity elimination/elimination of inter-entity transactions and balances 1. After the aggregation of the harmonised individual financial statements, all material balances and transactions between the consolidated entities have to be eliminated: - Balances and transactions between entities and resulting unrealised gains should be eliminated in full; and - 2. Only transactions with third parties should be shown in the consolidated financial statements. ### Goodwill or negative goodwill accounting/minority interests 1. In order to present financial information about the economic entity, as that of a single entity, the following steps are taken: - - 2. *The accounting for goodwill (negative goodwill), as well as minority (non-controlling) interests, has a very limited impact on the consolidated financial statements of the EU, as the institutions and agencies have not been acquired, but have been set up through the founding treaties or through an act of secondary legislation. Consequently, no goodwill may arise.* Joint operations ---------------- In relation to its interests in joint operations, the EU entity should recognise in their financial statements: a. b. c. d. e. Its expenses, including its share of any expenses incurred jointly. The EU entity shall account for the assets, liabilities, revenues and expenses relating to its interests in a joint operation in accordance with the EU accounting rules applicable the particular assets, liabilities, revenues and expenses. If the EU entity participates in a joint operation, but has no joint control, it accounts for its interests in a joint operation in the following way: - It recognises its assets, liabilities, revenue and expenses in accordance with the applicable EU accounting rules in case it has rights to assets of the joint operation and obligation for its liabilities; or - It accounts for its interests in the joint operation by applying equity method if it has significant influence over the joint operation structured via a separate vehicle; otherwise - It accounts for its interests in accordance with the EU accounting rule no 11\"Financial Instruments\". Associates and joint ventures ----------------------------- ### Application of equity method 1. In its consolidated financial statements, the EU entity should report its interest in a joint venture or associate using the equity method. 1. If the EU entity participates in a joint venture, but has no control of the joint venture nor significant influence, it should account for its interests in the joint venture in accordance with the EU accounting rule no 11\"Financial Instruments\". ### Equity method procedures 2. The equity method is a consolidation method whereby the investment is initially recorded at cost and adjusted thereafter for the post-acquisition change in the EU entity\'s share of capital of an associate/joint venture. The statement of financial performance reflects the EU entity\'s share of the results of operations of the associate/joint venture. Unrealised surpluses and deficits resulting from all transactions between the EU entity and its associates/joint ventures should be eliminated for an amount equal to the EU entity\'s interest in the associate/joint ventures. Instead of including all assets and liabilities, revenues and expenses of the associate/joint venture in the consolidated financial statements, only the investment and its result of the year shall be booked. 3. Investments in associates and joint ventures accounted for using the equity method should be classified as non-current assets. 4. The EU entity\'s share of changes recognised directly in the associate's or joint venture\'s net assets/equity shall be recognised directly in net assets/equity of the EU entity. 5. If the EU entity\'s share of deficits of an associate/joint venture equals or exceeds its interest in the associate/joint venture, the EU entity discontinues recognising its share of further losses. After the EU entity\'s interest is reduced to zero, additional losses are provided for, and a liability is recognised, only to the extent that the EU entity has incurred legal or constructive obligations or made payments on behalf of the associate/joint venture. If the associate/joint venture subsequently reports surpluses, the EU entity resumes recognising its share of those surpluses only after its share of the surpluses equals the share of deficits not recognised. ### Transactions between an investor and its associate/joint venture 6. When an investor (joint venturer / partner in an associate) contributes or sells assets to an associate/joint venture, recognition of any portion of a gain or loss from the transaction shall reflect the substance of the transaction. While the assets are retained by the associate/joint venture, and provided the EU entity has transferred the significant risks and rewards of ownership, the EU entity shall recognise only that portion of the gain or loss that is attributable to the interests of the other investors. The EU entity shall recognise the full amount of any loss when the contribution or sale provides evidence of a reduction in the net realisable value of current assets or an impairment loss. 7. When the EU entity purchases assets from an associate/joint venture, the EU entity shall not recognise its share of the gains of the joint venture from the transaction until it resells the assets to an independent party. The EU entity shall recognise its share of the losses resulting from these transactions in the same way as gains except that losses shall be recognised immediately when they represent a reduction in the net realisable value of current assets or an impairment loss. ### Impairment losses 8. After application of the equity method, including recognising the investments losses in accordance with chapter 5.4.2, the EU entity applies the provisions in the EU accounting rule 11 to determine whether it is necessary to recognise any additional impairment loss with respect to the EU entity\'s net investment and the amount of the impairment loss. Derecognition ============= Controlled entities ------------------- The EU entity should discontinue consolidation of an entity from the date on which it ceases to have control of the controlled entity. The assets and liabilities of the former controlled entity are derecognised from the consolidated balance-sheet/statement of financial position and the retained investment is measured at fair value at that date. The fair value is regarded as the fair value on initial recognition of a financial asset in accordance with the EU accounting rule 11 or the costs on initial recognition of an investment in an associate or joint venture. Finally, the EU entity recognises the gain or loss associated with the loss of control attributable to the former controlling interest. Associates and joint ventures accounted for using the equity method ------------------------------------------------------------------- 1. The EU entity should discontinue the use of the equity method from the date that it ceases to have significant influence in an associate or joint control in a joint venture but retain, either in whole or in part, their investment. 2. If the retained interests in the former associate or joint venture is a financial asset, the EU entity should measure the retained interests at fair value at the date the investment ceases to be an equity investment. The fair value of the retained interests shall be regarded as its fair value on initial measurement as a financial asset in accordance with the EU accounting rule 11. If there is no quoted market price in an active market for the retained equity investment and the variability in the range of reasonable fair value estimates is significant and the probability of the various estimates cannot be reasonably assessed, the EU entity measures the retained interests at the carrying amount of the investments at the date that it ceased to be an associate or joint venture. 3. If the investment becomes a controlled entity, the EU entity accounts for it in line with point 5.2 of this accounting rule. 4. If an investment in an associate becomes an investment in a joint venture or an investment in a joint venture becomes an investment in an associate, the EU entity continues to apply the equity method and does not remeasure the retained interests. Disclosures =========== An EU entity shall consider level of detail necessary to satisfy the disclosure objective. It shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or aggregation of items that have different characteristics. Controlled entities ------------------- ### Significant judgements and assumptions 1. An EU entity shall disclose in its consolidated financial statements the methodology it has used in determining that it has control of another entity. In particular, the EU entity shall disclose, where applicable *and material*, the factors considered in determining that: a. b. c. d. ### Listing of consolidated entities 2. The consolidated financial statements should include a list of significant controlled entities including for each of its controlled entities: the name, the jurisdiction in which it operates (when it is different from that of the controlling entity), proportion of ownership interest and, where that interest is in the form of shares, the proportion of voting power held (only where this is different from the proportionate ownership interest). 3. In addition, for each of its controlled entities that have non-controlling interests that are material in the EU entity\'s consolidated financial statements, the EU entity shall disclose the proportion of ownership interests held by non-controlling interests and the proportion of the voting rights held by non-controlling interests (if different from the proportion of ownership interests held); the surplus or deficit allocated to non-controlling interests of the controlled entity during the reporting period, accumulated non-controlling interests of the controlled entity at the end of the reporting period; and summarised financial information about the controlled entity. ### Nature and extent of significant restrictions 4. An EU entity shall disclose in its consolidated financial statements the nature and extent of any significant restrictions (e.g. resulting from borrowing arrangements or regulatory requirements) on its ability to access or use the assets and settle the liabilities of the economic entity such as restrictions to transfer funds to the EU entity in the form of cash or other assets to (or from) other entities within the economic entity, as well as guarantees or other requirements that may restrict dividends and other capital distributions being paid, or loans or advances being made or repaid. 5. An EU entity shall disclose the carrying amounts in the consolidated financial statements of the assets and liabilities to which those restrictions apply. ### Nature of risk associated with interest in consolidated structured entities 6. An EU entity shall disclose the nature of the risks associated with an entity\'s interests in consolidated structured entities. In particular, an EU entity shall disclose the terms of any binding arrangements that could require the controlling entity or its controlled entities to provide financial support to a consolidated structured entity, including events and circumstances that could expose the reporting entity to a loss (e.g. liquidity arrangements). 7. An EU entity shall disclose the type and amount of the financial or other support provided to the consolidated structured entity during the reporting period without having contractual obligation to do so; as well as the reasons for providing the support. The EU entity shall disclose as well cases in which it assisted the structured entity in obtaining financial support. 8. If during the reporting period a controlling entity or any of its controlled entities has, without having a contractual obligation to do so, provided financial or other support to a previously unconsolidated structured entity and that provision of support resulted in the entity controlling the structured entity, the EU entity shall disclose an explanation of the relevant factors in reaching that decision. 9. An EU entity shall disclose any current intentions to provide financial or other support to a consolidated structured entity, including intensions to assist the structured entity in obtaining financial support. ### Consolidation procedures 10. An EU entity shall disclose in its consolidated financial statements the reporting date of the financial statements of a controlled entity when such financial statements are used to prepare consolidated financial statements and are as of a reporting date or for a period that is different from that of the EU and the reason for using a different reporting date or period. 11. If applicable, an EU entity shall disclose the fact that the consolidated financial statements have not been prepared using uniform accounting policies for like transactions and other events in similar circumstances due to impracticability, together with the proportions of the items in the consolidated financial statements to which the different accounting policies have been applied. ### Changes in a controlling entity\'s ownership interest in a controlled entity 12. An EU entity shall present a schedule that shows the effects on the net assets/equity attributable to owners of the controlling entity of any changes in its ownership interest in a controlled entity that do not result in a loss of control. 13. An EU entity shall disclose the gain or loss, if any, calculated in accordance with point 6.1 of this accounting rule and: Joint arrangements and associates --------------------------------- ### Significant judgements and assumptions An EU entity shall disclose the methodology it has used in determining that it has joint control of an arrangement or significant influence over another entity. In particular the EU entity shall disclose, where applicable and material, the factors considered in determining: ### Listing of significant associates and joint arrangements An EU entity should disclose a listing and description of interests in significant joint arrangements and associates including the following information: ### Summarised financial information for associates and joint ventures 1. As the EU entity reports its interests in associates and joint ventures using the equity method, it should disclose for each material associate or joint venture the amounts of dividends or similar distributions received from joint venture or associate and summarised financial information for the joint venture or associated including (*if applicable* *and material):* current assets, non-current assets, current liabilities, non-current liabilities, revenue, expense, pre-tax gain or loss recognised on the disposal of assets or settlement of liabilities attributable to discontinuing operation and surplus or deficit. 2. In addition, for each material joint venture the EU entity shall disclose *-- taking into account materiality considerations* - cash and cash equivalents, current and non-current financial liabilities (excluding taxes and transfers payable, payables under exchange transactions and provisions), depreciation and amortisation, interest revenue, interest expense and income tax expense. 3. An EU entity shall provide in its consolidated financial statements reconciliation between the carrying amount of its interests in the associate or joint venture (as accounted for by using the equity method) and the summarised financial information disclosed for each material associate and joint venture (based on the associate\'s or joint venture\'s financial statement adjusted to reflect adjustments made by the EU entity when using the equity method). 4. An EU entity shall disclose in aggregate the carrying amounts of its interests in all not individually material joint ventures and associates (separately for joint ventures and associates) and the aggregate amount of its share of those joint ventures\' or associates\' revenue, tax expense, pre-tax gain or loss recognised on the disposal of assets or settlement of liabilities attributable to discontinuing operations, surplus or deficit. 5. An EU entity does not need to provide disclosures required under the points 1-4 above for the investments in the joint ventures or associates which are held through interests in an investment entity, in which case these investments are measured at fair value in the EU accounts. ### Application of equity method to interests in associates and joint ventures 6. An EU entity shall disclose for each material associate and joint venture whether the investment in the joint venture or associate is measured using the equity method or at fair value and the fair value of the investment in an associate or joint venture accounted for using the equity method, if there is a quoted market price for the investment. 7. An EU entity shall disclose the unrecognised share of losses of an associate or joint venture, both for the reporting period and cumulatively, if the EU entity has discontinued recognition of its share of losses of an associate or joint venture. 8. An EU entity shall disclose the reporting date of the financial statements of an associate or joint venture, when such financial statements are used in applying the equity method and are as of a reporting date or for a period that is different from that of the EU entity, and the reason for using a different reporting date or different period. ### Significant restrictions on funds transfers An EU entity shall disclose the nature and extent of any significant restrictions (e.g. resulting from borrowing arrangements or regulatory requirements) on the ability of associates or joint ventures to transfer funds to the investor in the form of cash dividends, or similar distributions, or repayment of loans or advances. ### Risks associated with interests in associates and joint ventures An EU entity shall disclose: 2. Contingent liabilities that the EU entity incurred in relation to their interests in joint ventures or associates including its share of the contingent liabilities which have been incurred jointly with other investors with joint control of a joint venture or significant influence over an associate; separately from the amount of other contingent liabilities; 3. Interests in unconsolidated controlled entities (investment entities) --------------------------------------------------------------------- If the EU entity controls an investment entity, it shall disclose the following information in relation to its interests in the investment entity: 1. The fact that it has control over an investment entity and as such is required to apply the fair value measurement to the investments of the controlled investment entity. 2. For each controlled investment entity: the controlled entity name, the domicile and legal form of the controlled entity and the jurisdiction in which it operates, and the proportion of ownership interest held by the EU entity and, if different, the proportion of voting rights. 3. The information required under the above point shall also be provided for each entity controlled by the controlled investment entity. 4. The nature and extent of any significant restrictions arising from binding arrangements (e.g. resulting from borrowing arrangements, regulatory requirements or contractual arrangement) on the ability of a controlled investment entity to transfer funds to the EU entity in the form of cash dividends, or similar distributions, or to repay loans or advances made to the unconsolidated controlled entity by the investment entity; and any current commitments or intentions to provide financial or other support to an unconsolidated controlled entity, including commitments or intentions to assist the controlled entity in obtaining financial support. 5. Interests in structured entities that are not consolidated ---------------------------------------------------------- ### Nature of interests 1\) An EU entity shall disclose qualitative and quantitative information about its interests in structured entities that are not consolidated, including, but not limited to, the nature, purpose, size and activities of the structured entity and how the structured entity is financed. 2\) If an EU entity has sponsored a structured entity that is not consolidated for which it does not provide information required by point 7.4.2.1) below (e.g., because it does not have an interest in the entity at the reporting date), the EU entity shall disclose: a\) How it has determined which structured entities it has sponsored; b\) Revenue from those structured entities during the reporting period, including a description of the types of revenue presented; and c\) The carrying amount (at the time of transfer) of all assets transferred to those structured entities during the reporting period. 3\) An EU entity shall present the information in points (b) i (c) in tabular format, unless another format is more appropriate, and classify its sponsoring activities into relevant categories. ### Nature of risks 1\) An EU entity shall disclose in tabular format, unless another format is more appropriate, a summary of: a\) The carrying amounts of the assets and liabilities recognized in its financial statements relating to its interests in structured entities that are not consolidated; b\) The line items in the statement of financial position in which those assets and liabilities are recognized; c\) The amount that best represents the entity's maximum exposure to loss from its interests in structured entities that are not consolidated, including how the maximum exposure to loss is determined. If an EU entity cannot quantify its maximum exposure to loss from its interests in structured entities that are not consolidated it shall disclose that fact and the reasons; and d\) A comparison of the carrying amounts of the assets and liabilities of the EU entity that relate to its interests in structured entities that are not consolidated and the EU entity's maximum exposure to loss from those entities. 2\) If during the reporting period an EU entity has, without having an obligation under a binding arrangement to do so, provided financial or other support to a structured entity that is not consolidated in which it previously had or currently has an interest (for example, purchasing assets of, or instruments issued by, the structured entity), the EU entity shall disclose the type and amount of support provided, including situations in which the entity assisted the structured entity in obtaining financial support; and the reasons for providing the support. 3\) An EU entity shall disclose any current intentions to provide financial or other support to a structured entity that is not consolidated, including intentions to assist the structured entity in obtaining financial support. Such current intentions include intentions to provide support as a result of obligations under binding arrangements and intentions to provide support where the entity has no obligation under a binding arrangement. Non-quantifiable ownership interests ------------------------------------ To the extent that this information has not already been provided under other disclosures, an EU entity shall disclose, in respect of each non-quantifiable ownership interest that is material to the reporting entity the name of the entity in which it has an ownership interest; and the nature of its ownership interest in the entity. Controlling interests acquired with the intention of disposal ------------------------------------------------------------- 1\) An EU entity shall disclose the following information regarding its interest in a controlled entity when, at the point at which control arose, the EU entity had the intention of disposing of that interest and, at the reporting date, it has an active intention to dispose of that interest: a\) The name of the controlled entity and a description of its key activities; b\) The rationale for the acquisition of the controlling interest and the factors considered in determining that control exists; c\) The impact on the consolidated financial statements of consolidating the controlled entity including the effect on assets, liabilities, revenue, expenses and net assets/equity; and d\) The current status of the approach to disposal, including the expected method and timing of disposal. 2\) The disclosures required by point 1) above shall be provided at each reporting date until the EU entity disposes of the controlling interest or ceases to have the intention to dispose of that interest. In the period in which the EU entity disposes of the controlling interest or ceases to have the intention to dispose of the controlling interest it shall disclose the fact that there has been a disposal or change of intention; and the effect of the disposal or change of intention on the consolidated financial statements. Effective date ============== This accounting rule shall be effective for annual financial statements covering periods beginning on or after 1 January 2016. Reference to other rules ======================== This accounting rule is based on the following IPSAS standards: IPSAS 35 \'Consolidated Financial Statements\' IPSAS 36 \'Investments in Associates and Joint Ventures\' IPSAS 37 \'Joint Arrangements\', and IPSAS 38 \'Disclosure of Interests in Other Entities\' In addition, the following articles of the FR are also relevant: - Article 141 concerning the presentation of the accounts and the scope of consolidation; - Article 147 and 148 concerning the timetable for establishment of the consolidated accounts; - Article 152 concerning the application of harmonised accounting rules/methods as well as a harmonised chart of accounts by all the Institutions and bodies referred to in article 141 FR; and - Article 208 concerning the adoption of a framework financial regulation to all bodies, set up by the EU and having a legal personality, which actually receive contributions charged to the EU budget. Appendix {#appendix.ListParagraph} ======== Decision tree concerning the different types of control ------------------------------------------------------- The decision tree set out below maps out how to determine the nature of control that one entity has over another and the subsequent accounting treatment to be adopted. - - Yes - - - - No - - Yes No - - - No Yes No Yes No Yes {#section.ListParagraph} Type of control and type of entity ---------------------------------- ::: {.section.footnotes} ------------------------------------------------------------------------ 1. ::: {#fn1} Regulation (EU, Euratom) No 966/2012 of the European Parliament and of the Council of 25 October 2012 on the financial rules applicable to the general budget of the Union and repealing Council Regulation (EC, Euratom) No 1605/2002 (OJ L 298, 26.10.2012, p. 1).[↩](#fnref1){.footnote-back} ::: :::
