Consolidated Financial Statements

CONSOLIDATION IFRS 10 Presentation by: Fred Sporta (Ph.D Fellow) Friday, 5th May, 2017

Uphold public interest

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Understanding the scope of consolidation 

Conditions for consolidation 

Disclosure requirements

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Question: Why are entities required to present consolidated financial statements?  Provide information about economic entity ▪ investors need information about all assets and liabilities of combined entity  Definition of asset based on control: ▪ with control, entity can dictate use or settlement ▪ control through an entity is indirect control  Do not want legal form to dictate financial reporting 3

PRIMARY USERS OF FINANCIAL INFORMATION

Consolidat ed financial informatio n (A+B+C)

Other credit ors

Lende rs

Inves tors

ECONOMIC ENTITY

ENTITY A (INVESTOR)

CONTROLS

ENTITY B

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CONTROLS

ENTITY C

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

DOES NOT CONTROL

ENTITY D

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New standards IFRS 10 - Consolidated Financial Statements – replaced most of IAS 27 IFRS 11 - Joint Arrangements – replaces IAS 31 IFRS 12 – Disclosure of Interests in Other Entities – replaced parts of IAS 27 Revised Standards IAS 27 – Separate Financial Statements IAS 28 – Investments in Associates and Joint Ventures Effective from 1 January 2013 5

An entity that is a parent shall present consolidated financial statements (IFRS 10.4).  A parent is an entity that controls one or more entities  A subsidiary is an entity that is controlled by another entity (ie the parent)  A group is a parent and its subsidiaries  Consolidated financial statements are the financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. 

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A parent need not present consolidated financial statements if:  it is itself a wholly-owned subsidiary;  its securities are not publicly traded or in the process of becoming publicly traded; and  its parent publishes IFRS-compliant financial statements that are available to the public. This is also the case for a partly-owned subsidiary if its other owners have been informed about, and do not object to, it not presenting consolidated financial statements. 7

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IFRS 10 does not apply to post-employment benefit plans or other long-term employee benefit plans to which IAS 19 Employee Benefits applies. IFRS 10 provides an exception from the requirements of consolidation for an investment entity which is instead required to measure its subsidiaries at fair value through profit or loss (annual periods beginning on or after 1 January 2014). 8

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Over view Of IFRS 10 History Of IFRS 10

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Entities Likely to be affected By IFRS 10

Key Changes Of IFRSs 10 And IAS 27,Scope Key Principles/Objectives Key definitions.  Requirement For Consolidation , Control.  Application Of Control Model , Specific Guidance  Consolidation Procedure  Disclosure Requirement Of Ifrs 10  Challenges and How to Overcome them.   

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IFRS 10 Consolidated Financial Statements outlines the requirements for the preparation and presentation of consolidated financial statements, requiring entities to consolidate entities it controls

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Control requires exposure or rights to variable returns and the ability to affect those returns through power over an investee.

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IFRS 10 was issued in May 2011 and applies to annual periods beginning on or after 1 January 2013. 11

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April 2002-Project on consolidation added to the IASB's agenda 18 December 2008-ED 10 Consolidated Financial Statements published 20 september 2010-Staff draft of IFRS 10 Consolidated Financial Statements published 12 may 2011-IFRS 10 Consolidated Financial Statements published 12

28 June 2012-Amended by Consolidated Financial Statements, Joint Arrangements and Disclosure of Interests in Other Entities: Transition Guidance.  31st October 2012-Amended by Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27)  11 sept.2012-Amended by Sale or Contribution of Assets between an Investor and its Associate or Joint Venture (Amendments to IFRS 10 and IAS 28)  18th dec.2014-Amended by Investment Entities: Applying the Consolidation Exception (Amendments to IFRS 10, IFRS 12 and IAS 28) 

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1976 - IAS 3: Majority Share holding

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1989 - IAS 27: Control (Power to govern)

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2003 - SIC 12: Risk & Reward

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2013 - IFRS 10: Power+Exposure+Ability

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Phase 1 (1976-89) 

IAS 3 Consolidated Financial Statements

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Criteria for consolidation:

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Majority Share holding (≥ 51%)

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Reasons for moving from Phase 1 to Phase 2: 

Deregulation & “free for all” attitude

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Financial engineering & creative accounting

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Proliferation of Investment Banking, Private Equity Firms, Venture Capita Funds , etc.

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Investment Banking, Private Equity Firms, Venture Capita Funds , etc. 16

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Phase 2 (1989-2003) ▪

IAS 27 Consolidated Financial Statements

▪Criteria for consolidation: ▪Control (Power to govern)

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Reasons for moving from Phase 2 to Phase 3:

▪Enron Scandal (2001) ▪Abuse of Special Purpose Vehicles

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Phase 3 (2003-2008) ▪

SIC 12 Consolidation - Special Purpose Entities

▪Criteria for consolidation: ▪Risk & Reward

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Reasons for moving from Phase 3 to Phase 4:  

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Corporate greed & Regulator’s apathy To improve the usefulness of consolidated financial statements by developing a single basis for consolidation and robust guidance for applying that basis to situations in which it has proved difficult to assess control in practice. The basis for consolidation is control and it is applied irrespective of the nature of the investee. Sub prime mortgage Bearsterns & Lehman Brothers Domino effect & global crisis 20

 Phase 4 (Since 2013 )  IFRS 10 Consolidated Financial Statements  Criteria for consolidation: PEA Power, Exposure & Ability

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May sanity prevail! “Insanity is doing the same thing in the same way again and again and expecting different results” - Anon.

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Owners with less than 50% ownership Owners with less than 50% voting rights Holders of potential voting rights Entities To which power has been delegatedIFRS 10 provides guidance Special purpose entities-SPE(Structured entities) Agent versus principle relationships. 23

IAS 27 Control is the power to govern the financial and operating policies , so as to obtain benefits from its activities, while for SIC-12 focuses on risks and rewards for assessing Control. Control without a majority of voting rights-

IFRS 10 Control is when the investee is exposed or has rights to variable returns from its involvement with investee has the ability to affect returns though its power. IFRS10 states that an investor can control and

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IAS 27 Control without a majority of voting rightswas not explicitly stated i.e was implicit.

IFRS 10 IFRS10 states that an investor can control and investee with less than 50% of the voting rights of the investee.

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IAS 27 Potential voting rightsOnly currently exercisable potential voting rights are considered when assessing control. Agency relationships;IAS 27(2008) has no specific guidance regarding situations when power is delegated

IFRS 10 Potential voting rights need to be considered in assessing control, but only if they are substantive. IFRS 10 contains specific application guidance for agency relationships. 26

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IFRS 10 replaces all of the guidance on control and consolidation in IAS 27, ‘Consolidated and separate financial statements’, and SIC-12, ‘Consolidation − special purpose entities’.

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IAS 27 {previously called consolidated and separate financial statements} is renamed ‘Separate financial statements’; it continues to be a standard dealing solely with separate financial statements. The existing guidance for separate financial statements is unchanged. 27

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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. The standard;

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1. Requires a parent entity (an entity that controls one or more other entities) to present consolidated financial statements.

2. Defines the principle of control, and establishes control as the basis for consolidation.

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3. Set out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee. 4. Sets out the accounting requirements for the preparation of consolidated financial statements. 5. Defines an investment entity and sets out an exception to consolidating particular subsidiaries of an investment entity. 30

Parent-An entity that controls one or more entities Power-Existing rights that give the current ability to direct the relevant activities.  Protective rights-Rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate.  Relevant activities-Activities of the investee that significantly affect the investee's returns.  

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An investor will be required to consolidate an investee if it has all of the following;(control)  Power over the investee  Exposure, or rights, to variable returns from its involvement with the investee  The ability to use its power to affect the amount of the investor’s returns.

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Exposure to variable returns

Link Power return

control 33

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 CONTROL

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POWER OVER THE INVESTEE.

Existing rights that give the current ability to direct the relevant activities of the investee

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Exposure or rights to Variable returns

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Returns that are not fixed and have the potential to vary with performance of the investee

Ability to use power To affect Returns

Link betwe en power and returns 34

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 Rights

 Relevant activities

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Power = existing rights that give it the current ability to direct the relevant activities Power arises from rights (eg voting rights, rights to appoint key personnel, among others) Relevant activities: significantly affect the investee’s returns An investor need not have absolute power to control an investee 35

Definition of control: concept of returns is used in two ways  power  ability to direct relevant activities (ie directing inconsequential activities is not relevant to assessment of power)  rights, or exposure, to variable returns  Broad definition of returns: dividends; remuneration from services, fees and exposure to losses; residual interests on liquidation; tax benefits; access to future liquidity; returns not available to other investors (eg synergies) 

Exposure (or rights) to variable returns of the investee

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Ability to use power over the investee to affect its own returns

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Power + rights = necessary conditions for control (but still not enough) To control an investee, an investor must also have the ability to use its power to affect investor’s returns from its involvement with the investee Control = power that can be used to benefit the investor Returns and power: need not be perfectly correlated Only one party can control an investee 37

(i) The purpose and design of the investee (ii) What the relevant activities are and how decisions about those activities are made  (iii) Whether the rights of the investor give it the current ability to direct the relevant activities  (iv) Whether the investor is exposed, or has rights, to variable returns from its involvement  (v) Whether the investor has the ability to use its power to affect the amount of the investor’s returns.  

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The steps in applying the control model;  Identify the investee.  Understand the purpose and design of the investee.  Identify the relevant activities of the investee and how decisions about these relevant activities are made.

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The assessment of control is made at the level of each investee. However, in some circumstances, the assessment is made for a portion of an entity (i.e. a silo). That is the case if, and only if, all the assets, liabilities and equity of that part of the investee are ring-fenced from the rest of the entity. The existence of silos is not confined to structured entities but is more likely to arise there. 42

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This is necessary in order to: Identify what the relevant activities of the investee are; Understand how decisions about the relevant activities are made; Determine who has the current ability to direct those activities; and Determine who receives returns from the activities. 43

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Relevant activities are the activities of the investee that significantly affect the investee’s returns. Examples of activities that, depending on the circumstances, can be relevant activities include: Selling and purchasing of goods or services; Managing financial assets during their life (including on default); 44

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Selecting, acquiring or disposing of assets; Researching and developing new products or processes; and Determining a funding structure or obtaining funding. Examples of decisions made about relevant activities include: Establishing operating and capital budgets; 45

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The following topics, which were not covered (or covered in less detail) by IAS 27(2008)/SIC12  De-facto control  Principal – Agent relationships  Silos  Franchises.

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Power without a majority of voting rights, occurs where:  Contractual arrangements with other vote holders exist  Relevant activities directed by arrangements held.  The investor has practical ability to unilaterally direct relevant activities, considering all facts and circumstances. 49

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Entity A owns 45 per cent of the ordinary shares of Entity B to which voting rights are attached. Entity A is the largest shareholder of Entity B. It also has the right to appoint the majority of the members of the Board of Directors (the management board) of Entity B in accordance with special rights given to Entity A in the founding document of the entity. 51

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Entity A and B each have 50% ownership interest in the trust.

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Entity A appointed as manager of trust.

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Manager: manages the assets of the trust, identifies development opportunities, manages development activity and manages leasing activity. Cannot be removed without cause.

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Relevant activities?

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Who directs? 52

Responsible entity: Other Broad decision making powersResponsible Entity Investors Removal by simple majority Remunerated via marketbased fee - 1% of assets under Investment Trust management and 20% of profits over a hurdle Equity interest of 20% Investment portfolio 53

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Group Consolidated Financial Statements

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Parent’s Separate Financial Statement

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Subsidiary’s Separate Financial Statement

Consolidated Financial statements are financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity 54

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Step 1:Combine like items of assets and Liabilities, Income, expenses and Cash flows of the parent with those of the subsidiary. Step 2:Offset(eliminate)-carrying Amount Of Parents Investment In the Subsidiary Parents Portion Of equity of each Subsidiary. Step 3:Offset(Eliminate)-items related to intergroup transactions. 55

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Parent and subsidiaries must have uniform accounting policies and reporting dates. If not, alignment adjustments must be quantified and posted to ensure consistency. Reporting dates cannot vary by more than 3 months. Consolidation of an investee begins from the date the investor obtains control of the investee and ceases when the investor loses control of the investee. 56

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The objective of IFRS 12 is for an entity to disclose information that helps users of financial statement to evaluate;

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The nature of, and risks associated with, its interests in other entities. Effect of those interests in its financial position, financial performance and cash flows.

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An entity shall disclose information that enables users of its consolidated financial statements; (a) To understand: (i) the composition of the group; and (ii) the interest that non-controlling interests (b) To evaluate: (i) The nature and extent of significant restrictions on its ability to access or use assets, and settle liabilities, of the group; 58

(ii) the nature of, and changes in, the risks associated with its interests in consolidated structured entities; (iii) The consequences of changes in its ownership interest in a subsidiary that do not result in a loss of control; and (iv) The consequences of losing control of a subsidiary during the reporting period. 59

For each subsidiary that has non-controlling interests that are material to the group, an entity is required to disclose the following:  Name  Principal place of business (and country of incorporation if different)  Proportion of ownership interests held by noncontrolling interests (and proportion of voting rights held, if different) 60

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Profit or Loss allocated to non controlling interest during the reporting period. Accumulated non-controlling interests at the end of the reporting period Dividends paid to non-controlling interests Summarized Financial information

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The summarized financial information should should provide information about assets, liabilities, profit or loss , and cash flows, subsidiary that enables users to understand the interest that non-controlling interests have in the group’s activities and cash flows but states that certain information might include but is not limited to: 

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Non current assets Current assets Current liabilities Non current liabilities Revenue Profit or Loss Total Comprehensive Income

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An entity needs to decide, in light of its circumstances:  How much detail it provides to satisfy the information needs of users  How much emphasis it places on different aspects of the requirements  How it aggregates the information  Entities should pay close attention to the requirements for aggregation which are new and prescriptive 64

How to consolidate an investee that is not a business for the first time – ‘IFRS 10 does not elaborate on how to apply the acquisition method as described in IFRS 3’ to non-business acquisitions, in particular, the guidance on acquisitions costs, deferred taxes and contingent consideration.  Judgment will need to be exercised in determining which aspects of the acquisition method in IFRS 3 are applicable to non-business acquisitions. 

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How to address the impact of other standards IFRS 10 does not explicitly address the impact of other standards, such as: IAS 12,IAS 21 ,IAS 23,IAS 36,IAS 39.

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The application of these standards and their interaction with IFRS 10 would need to be evaluated to determine whether they give rise to additional adjustments on transition. 66

How an entity has assessed whether it is impracticable (as defined in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors) for it to consolidate an investee from the date control was acquired under IFRS 10 or to de-consolidate an investee from the date control was lost, and how it identified the earliest period that it became practicable . This assessment requires significant judgment based on the characteristics of the investee, including its age and all available information. 67

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Entities now need to be on watch for changes affecting any one of the 3 elements of control–this includes A change in an investor’s decision-making rights; A lapse of rights held by other parties, or A change in whether the investor acts as a principal or an agent. 68

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