Conceptual Framework Phase D — Reporting Entity
Determining the composition of a group reporting entity for financial reporting purposes
The Board discussed the following approaches:
- Controlling entity model
Under this model, the area of economic interest is circumscribed by the extent of one entity's control over other entities. A group entity comprises the controlling entity (i.e. the parent) and other entities under its control (i.e. its subsidiaries). Accordingly, the model is broadly similar to the control model currently used today, but with control defined to include both a power element and a benefits element.
- Common control model
Under this model the area of economic interest comprises those entities that are under the common control of the same controlling entity or controlling body. The key difference between the common control model and the controlling entity model is that, under the controlling entity model, the parent entity is always included in the group reporting entity, whereas the inclusion of the parent entity or controlling body is not essential under the common control model. This allows for the possibility of preparing 'group' general purpose external financial reports (GPEFR), prepared by combining the assets, liabilities and activities of the entities under common control, even though the parent entity or controlling body might not be required to (or might not choose to) prepare GPEFR.
- Synergistically managed assets approach
This approach was discussed by the Board for the first time. The area of economic interest, both for an individual entity and group entity, is circumscribed by the group of net assets that are managed synergistically together to generate returns to investors, creditors and others. Accordingly, the boundary of the reporting entity would not necessarily correspond to the boundary of a legal entity.
The staff pointed out that last week the FASB has reaffirmed that they prefer the controlling entity model but that the common control model should not be ruled out. The FASB did not pursue the synergistically managed assets approach. The Board expressed mixed views and was nearly equally split between controlling entity model or the common control model as preferred model but it appeared that no one wanted to rule out the respective other model. One Board member noted that the controlling entity model is a particular case of the common control model.
The synergistically managed assets approach was not pursued but some Board members pointed out that this approach might be useful in determining the reporting entity under the common control model.
Finally, there appeared to be a consensus that on a conceptual level the composition of the group reporting entity should be based on 'control' with the controlling entity model as 'main driver'. The decision whether the controlling entity model or the common control model should be required in certain circumstances should be made at the standards level.
Parent-only financial statements and consolidated financial statements
The Board continued its deliberations regarding the following issues:
This issue addresses the question whether both sets of financial statements relate to the same entity, or two different entities. In previous discussions the following views were expressed:
View 1: Parent is the Group View
This view comprises the views formerly labelled 'One Entity - Two Alternative Displays' and 'One Entity - One Display'. The parent entity and the group entity are regarded as one and the same entity. The subsidiary entity is regarded of being part of the parent entity, for the purposes of the parent entity's financial reporting, akin to an unincorporated branch.
View 2: Parent not the same as Group View
This view represents the 'Multiple Entities' view. Under this approach, the subsidiary entity and the parent entity represent two separate entities (two separate 'circumscribed areas of economic interest'), while the group entity is a third entity (that is, a third 'circumscribed area of economic interest[) that encompasses within its boundary both the parent entity and the subsidiary entity.
The Board decided to no longer focus on this issue but to address exclusively the presentation issue. According to staff the FASB decided in the same way.
This issue determines which set of financial statements (or both) meets the objective of general purpose external financial reporting, by providing decision-useful information to present and potential investors, creditors and other external users with a financial interest in the parent entity.
The following views were discussed:
Both parent-only financial statements and consolidated financial statements are capable of providing decision-useful information to external users. The parent entity can have only one set of general purpose external financial statements (GPEFS), but it can include other financial information within its single set of GPEFR. In particular, the parent's GPEFR could include both consolidated and parent-only financial statements. For example, there could be 'parent' and 'group' columns in each of its primary financial statements, or one set of financial statements presented as its GPEFS with another set of financial statements provided as supplementary information, all within a single set of GPEFR.
Both parent-only financial statements and consolidated financial statements are capable of providing decision-useful information to external users. However, the parent entity can have only one set of GPEFS and it would be a standards-level issue to determine how the parent should present information about the subsidiary's assets, liabilities and activities. That standards-level issue is to determine, in a given set of circumstances, whether users' information needs would best be served by presenting, in the parent's GPEFS, information about its net investment in the subsidiary (as is done now in parent-only financial statements) or information about the underlying assets and liabilities of the subsidiary (as is done now in consolidated financial statements).
The parent entity can have only one set of GPEFS, which are its consolidated financial statements, because consolidated financial statements present information about all the parent's assets, liabilities and other activities, whereas parent-only financial statements do not. Parent-only financial statements present information about the parent's investment in its subsidiaries, not the underlying assets, liabilities and activities. Therefore, assets, liabilities, revenues and expenses are omitted (or offset), which is not a relevant or faithful representation of the parent entity's assets, liabilities, revenues and expenses. This should be explained at the concepts level. Parent-only financial statements should be treated as special purpose financial statements, and should be precluded from being described as GAAP-compliant, that is, should not be described as prepared in accordance with IFRS or US GAAP.
The staff informed the Board that the FASB was somewhere in between views B and C, that is, that an entity should only have one set of (consolidated) financial statements. The FASB acknowledged that there might be circumstances when parent-only financial statements should be permitted but that such exceptions should be addressed on standards-level only.
The Board was nearly equally split between view A and view C while view B was unanimously turned down. Those in favour of view C noted that there might be circumstances where parent-only financial statements could provide decision-useful information but they disagreed to require parent-only financial statements in all circumstances. One Board member in favour of view A noted that this approach would resolve the issue with investment companies, that is, to have the value of the investments in one line and to provide dividend information.
The Board did not come to a conclusion. For purposes of the Discussion Paper the Board decided to include a preliminary view that consolidated financial statement are considered to be the more important set of financial statements and to ask the constituents whether parent-only financial statements should be required in all circumstances or only occasionally.
The Board directed the staff to proceed drafting the Discussion Paper.