Conceptual Framework Phase B — Elements and Recognition and Phase D — Reporting Entity
As part of their deliberations on the development of an asset definition, the Board identified a cross-cutting issue: what constitutes the asset when an entity holds an option over an asset? The Board decided that it had to agree on the accounting for an option to acquire/sell an asset directly as part of their deliberations on treatment of options held over entities.
After a short discussion, the Board concluded that the only asset that the entity would have is the option that it holds over the asset and not the underlying asset itself.
The Board has identified eight cross-cutting issues in the Reporting Entity phase of its project on the Conceptual Framework. The Board discussed a paper that (a) summarised all previous Board decisions about the reporting entity and (b) identified remaining issues. The session was split into three major sections.
- Individual reporting entity
- Group reporting entity
- Control issues
The staff noted that the Board had decided that the conceptual framework related to general purpose external financial reports (GPEFR) and that the analysis presented considered only issues related to this. It was also noted that the analysis only considered issues from a conceptual level as different considerations might apply when considering the issues at a standard-setting level.
Individual Reporting Entity
The Board considered the following issues regarding the individual reporting entity:
- whether further research is necessary about what constitutes an 'individual entity' for financial reporting purposes, and
- whether the conceptual framework should describe what constitutes an individual entity, but not define it.
The Board agreed that further research about what constitutes an individual entity is unnecessary. It also decided that the conceptual framework should discuss what constitutes an individual entity but should not develop a definition.
Group Reporting Entity
Most of the session on the conceptual framework was devoted to discussing cross-cutting issues related to the Group reporting entity. In the discussion, Board members tried to understand what would distinguish the models presented (described in materials not available to observers).
The Board discussed the following issues:
- What is the purpose of consolidated financial statements? Why do some jurisdictions require parent-only financial statements, others require consolidated financial statements, and others combined financial statements?
- Is 'control' the right basis for consolidation?
- What does 'control over an entity' mean? Should this be defined at the concepts level or at the standards level?
Parent entity versus group entity
The Board noted that different views about the reporting entity concept, including different views about whether a parent-only entity can prepare 'general purpose financial statements' and, if so, whether different accounting requirements are appropriate. The Board had previously asked the staff to research whether a parent-only entity could be a reporting entity for the purposes of general purpose financial statements instead of or in addition to a group's consolidated financial statements. Previously, the Board agreed that a parent-only entity could be a reporting entity, but individual Board members reached that conclusion using different approaches. The staff therefore developed three approaches for the Board to consider:
- One entity-Two displays: Under this approach, the consolidated financial statements are regarded as being an alternative way of presenting information about the same set of assets, liabilities, and activities that appear in the parent-only financial statements. The entity can choose which to present. The Parent-only financial statement would be regarded as general purpose financial statements.
- One entity-One display: The consolidated financial statements are regarded as presenting information about a different set of assets and liabilities than the set of assets and liabilities that appear in the parent-only financial statements. The parent-only financial statements are not regarded as being general purpose external financial statements.
- Multiple entities: Under this approach, the parent-only financial statements relate to the parent entity. The consolidated financial statements relate to the group entity. Hence, both sets of financial statements are regarded as general purpose financial statements.
After a long debate that focused on trying to understand what distinguished the different approaches, the Board voted (9 members in favour) for the multiple entity approach (that is, both consolidated and parent-only entity could be a reporting entity).
Group reporting entities - approaches
The Board discussed the issue of when two or more entities should be combined and regarded as one entity for the purpose of providing financial information that is useful to both present and potential investors. The staff developed three models:
- Controlling entity model: A group entity comprises the controlling entity (the parent) and other entities under its control (its subsidiaries). Hence, the group is united by the parent entity's control over other entities. This approach requires that there be a parent entity.
- Common control model: In December 2005, the Board agreed that the staff should conduct further research into whether the boundaries of a group reporting entity should be based on a broader concept of control, for example, a concept that encompasses entities under common control.
- Risks and/or rewards model: Entities should be combined into a group entity when the activities of the second entity affect the wealth of the residual shareholders (or claimants) of the first entity.
The discussion around which model to apply was conducted in parallel with the debate on the parent entity versus the group entity debate above. As such, it was difficult to summarise the Board's discussion, as it was focused on trying to understand what the different models presented represented.
The Board seemed to agree that the group entity should be based on a 'modified controlling entity' model. This model will include 'sister-entities' as well as subsidiaries as part of the group. The Board voted 12-1 in favour of this model.
For the issues set out below, the Board was asked to agree (a) whether the issue should be dealt with in the conceptual framework project and (b) whether they agree with the conclusion on that issue.
- Temporary control: Control over another is based upon an assessment of the present facts and circumstances. Therefore, the concept of control does not exclude situations in which control exists but it might be temporary. The Board agreed.
- De facto or effective control: The control concept should not be limited to circumstances in which the entity has sufficient voting rights or other legal rights to direct the financing and operating policies of another entity, but should be a broad concept that encompasses economically similar circumstances. The Board agreed.
- Power is non-shared: An entity does not have power over another entity if the first entity must obtain the agreement of others to direct the financing and operating policies of the second entity. The Board agreed.
- Treatment of options: In concept, when options are considered in isolation, the fact that an entity holds enough options that, if and when exercised, would place it in control over another entity is not sufficient, in itself, to establish that the entity has present control of that other entity. However, there could be other facts and circumstances that, taken together, indicate that the entity has present control over the other entity. The Board agreed.
- Control, joint control and significant influence: Control involves one entity (not multiple entities) having control over another entity. Hence, the relationship between an individual venturer and the joint venture should not be described as a control relationship. Similarly, the relationship referred to as 'significant influence' should not be described as a control relationship. This will be addressed at a subsequent meeting.