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Consolidation

Date recorded:

Control model

The Boards continued their deliberations of control in the context of power with less than half of the voting rights in an entity that the Boards discussed at their meeting on 15 March 2010.

The Boards discussed the remaining two views that were supported by the respective majorities of the IASB and FASB. The staff clarified that the for the 'Ability view' the analysis of the situation is sufficient for determining the power element of control. On the other hand the 'Evidence view' (or 'Ability view with evidence') would require evidence of directing of activities in addition to the requirements of the 'Ability view'.

Despite improved articulation of views and discussion of examples the Boards remained split along the lines established in January and the previous Tuesday.

As one Board member described it, the main difference was whether or not to consolidate a 49% interest in an entity that the company did not actively direct.

One IASB member was concerned by the impact of each of these views on consolidation of structured entities. The staff clarified that as structured entities are usually not governed by voting rights and rights and obligations of all the parties are usually contractually defined narrowly, this discussion should have only limited impact on structured entities. Moreover, the structured entities would be assessed based on the control over the most significant activity rather than based on voting rights.

Another Board member was concerned by the issue of control in a transition stage (when a control shifted from one party to another). The staff responded that such issue is not unique for power with less than half of the voting rights in an entity (but is the same when a majority stake is transferred but the Board of Directors remain the same in a transition stage). As such the Boards did not decide to address this issue.

The Boards also discussed the nature of kick-out rights, noting that these might be assessed at the same time for determining who is not in control and in some circumstances also help to identify who is in control.

Some IASB members were concerned by the structuring opportunities when there was a need to evidence direction in case of a 49%-owned entity but not in case of a 51%-owned entity. The staff suggested that the level of the evidence should be viewed as operationalising the power element of control definition given the uncertainty of the below 50% voting rights in the entity. As such the staff suggested that the evidence need to be more detailed the lower was the ownership interest of the dominant shareholder.

Some FASB members expressed their concerns by the presentation of large non-controlling interest in the statement of financial position in case of interest of the dominant shareholder below 30%.

On voting the IASB supported the 'Ability view' and the FASB voted for the 'Evidence view'. The FASB then suggested that it would discuss both proposals in the Exposure draft.

The Boards continued the discussion with the aim to reconcile their positions. One IASB member suggested that the ability should be defined as a probable inaction of the shareholders (i.e. not just attendance at the meeting as some issues might increase their willingness to participate). Other IASB members disagreed as they believed that such guidance would be not operational (that is, would lead to consolidation only in over 50% situations). As one Board member noted, for some decisions supermajority (such asw 75%) is required and that did not mean that 51% shareholder would not consolidate.

One FASB member suggested including specific consideration of other contractual and non-contractual arrangements and not only voting rights (e.g. level of vertical integration etc.). The Boards would re-discuss the issue at the end of the Consolidation debate. The Boards continued their discussion with the assessment of the potential voting rights on the control model. Most of the Board members agreed that judgement was needed to be applied to assess whether potential voting rights are substantive by considering whether there are barriers that would prevent the holder from exercising its rights on the basis of current facts and circumstances.

One Board member suggested that the assessment should include the consideration of whether the entity does the decisions as soon as substantive decisions need to be made.

Some Board members suggested that the assessment of options should consider whether they are in the money or out of the money. The staff clarified that judgement would have to be applied as sometimes the assessment is not that clear (the assessment would not capture the expected synergies or specific value). In their opinion, all circumstances (and not just the options) have to be assessed to determine control as there is a great variety of different economic circumstances which might be interpreted differently.

The staff also clarified that the assessment of potential voting right would be further integrated in the model (and did not constitute a standalone criterion).

One IASB member discussed a fact pattern in which a company obtained an option to get 100% of another company (option deeply in the money) and asked the staff to assess whether to consolidate. Based on the discussion the Boards noted that the answer to this question would not be straightforward. One FASB followed up and asked how such a transaction would be accounted for under the Business Combinations guidance. The Boards agreed that they would need to consider the application of the purchase method to such scenario at a future meeting.

Agency relationship

The Boards followed up the discussion of the agency relationship from the January 2010 meeting. The Boards agreed that the evaluation whether a decision maker is an agent or a principal should be made on the basis of the following four factors that focus on the nature and design of the relationship:

  1. decision-making authority
  2. rights held by other parties
  3. remuneration of the decision maker
  4. the decision maker's exposure to variability of returns because of other interests that it holds in the entity.

The Boards noted that both power and risk and rewards (benefits) elements have to be fulfilled in the control model. The staff also clarified that all these four conditions for assessment of the agency relationship have to be considered as a whole package and not assessing separately fulfilment of the power and benefits elements of control.

Most of the further discussion of the Boards focused on detailed concerns of the individual Board members about the wording of the guidance. In particular, several Board members disagreed with the assumption that constraint of power within a narrowly defined remit (by contract, statue or law) does not necessarily mean to the entity acted as an agent. The staff clarified that it tried to capture the influence of the entity over the strategic policies and designed on the structure. Some FASB members were concerned by incorporation of the notion of probability or expectations into the model (for example, probability of fulfilment of the obligation, expected returns etc.).

Most of the Board members agreed that to conclude that an entity acts as an agent the fee structure must be aligned between the entities and variability of returns does not necessarily mean that the entity acts as a principal. They also agreed that one of the considerations in the fees structure would be whether or not it is market based.

Finally, the Boards confirmed that the all facts and circumstances must be considered in assessment of the agent/principal relationship (e.g. explicit as well as implicit guarantees, risks etc.).

One IASB member asked how these conditions on agent/principal relationship fit into the decisions made within the insurance project. The Boards decided to address this issue at a following meeting.

Related parties

Without much discussion the Boards agreed that:

  • when assessing control, the involvement and interests of a related party should be considered to be those of the reporting entity when the nature of the reporting entity's relationship with that related party is such that the related party is acting on behalf of the reporting entity (that is, when the relationship is such that the reporting entity, or those that direct the activities of the reporting entity, have the ability to direct the related party to act on behalf of the reporting entity in relation to its involvement with the other entity).
  • the list of potential related parties should include an entity for which the majority of the members of its governing body is the same as that of the reporting entity.

The IASB agreed that a party would often act for the reporting entity only if it cannot finance its operations without subordinated financial support from the reporting entity. It also agreed that 'a party that has a close business relationship like the relationship between a professional service provider and one of its significant clients' is a de facto agent. The IASB agreed to include these parties as related parties in the new consolidation standard.

Finally, the IASB agreed to include in the Standard the guidance on what to do when a related party is deemed to act for the reporting entity (similar to that in Topic 810 in the U.S. GAAP).

Guidance for Structured Entities

The Boards considered whether to provide a specific guidance for structured entities, what should be status of such guidance and how much level of detail it should provide.

Some Board members acknowledged the need for some sort of guidance but noticed that detailed guidance that would include bright lines would serve as a 'roadmap for structuring opportunities'.

The IASB members were concerned that by providing a specific guidance for structured entities might undermine the perception of the single control model for consolidation. The staff clarified that the additional guidance for structured entities would be a supplemental guidance that would just apply the control model in a particular situation (similar to voting rights guidance for entities with voting rights) rather than compete with it.

In general, the Boards were vary of providing too detailed guidance and asked the staff to incorporate only some of the ideas of the proposed separate guidance (that was inspired by the current guidance in the U.S. GAAP) in the overall control model. The Boards asked the staff to shorten the guidance that would fit into the overall control model, would avoid any rules or bright lines and supplement the generic guidance with a list of examples how this guidance would be applied.

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