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Assessing control over an entity

Dolphy D'Souza | Updated on: Jul 05, 2011

IFRS 10 does not change consolidation procedures. Rather, it decides whether an entity is consolidated by revising the definition of control.

The 2006 Memorandum of Understanding (MoU) between the IASB and the US Financial Accounting Standards Board (US FASB) included a joint project to eliminate differences between US GAAP and IFRS with respect to consolidation. As a result of this MOU and in response to the financial crisis, the IASB issued IFRS 10, which is a new standard on consolidation. IFRS 10 does not change consolidation procedures i.e., how to consolidate an entity.

Rather, IFRS 10 changes whether an entity is consolidated, by revising the definition of control.

De facto control

An investor might have control over an investee even when it has less than a majority of the voting rights of that investee (sometimes referred to as de facto control). In assessing whether de facto control exists, various factors are considered. For example, size of the investor's holding of voting rights relative to the size and dispersion of other vote holders. The more parties that would need to act together to outvote the investor, the more likely the investor is in control. In some cases, an investor might not have de facto control on its own, but may have potential voting rights or a contractual arrangement to direct others how to vote.Because there are no bright lines, applying this concept will require significant judgement of the facts and circumstances.

For example, how large does an investor's interest need to be relative to others? How widely dispersed do the other investors need to be? An investor could find itself in control simply because of circumstances that exist at a point in time, rather than because of deliberate action.

In some cases, where decision-making rights have been delegated or are being held for the benefit of others, it is necessary to assess whether a party is principal or agent to determine whether it has control. The rights held by de facto agents, and the returns received by such parties, are considered when evaluating whether an investor has control.

Significant change

IFRS 10 introduces a significant change from IAS 27 relating to the unit of account for which control is assessed. Similar to IAS 27, under IFRS 10, an investor is generally assessing whether it has control over an investee in its entirety. However, IFRS 10 goes beyond and states that, when assessing control, an investor also considers whether it has power specified assets of an investee, and whether this portion of an investee is considered to be a separate ‘deemed entity' (often referred to as a ‘silo').

Business Impact

New processes and systems may be needed to gather information (such as contracts, agreements and other data related to investments), to make judgements on control and consolidation, and to comply with new disclosure requirements.

Acquisition accounting will be required for investments that are now deemed to be controlled. Consolidation of entities that were hitherto kept out of the books would have significant impact on the balance sheet, income-statement, ratios, debt and compensation arrangements, market valuation, etc.

(The author is Partner and National IFRS Leader, Ernst & Young. The views expressed are personal).

Published on June 30, 2011
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