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Consolidation, Including Special Purpose Entities

Date recorded:

Discussion centred around the following three papers:

  • Paper A that discusses some of the high-level conceptual issues that arise
  • Paper B is staff summary of the comments received from IFRIC members and others on SIC-12, Consolidation - Special Purpose Entities.
  • Paper C sets out some of the high-level issues that are raised by the recent FASB proposals on the consolidation of SPEs.

Paper A - high-level conceptual issues

Discussions started by trying to get a basic framework in place to solve basic issues such as why do we consolidate, when do we consolidate and how do we consolidate. A control-based approach was proposed with a reporting entity notion, defining the reporting entity by reference to the assets it controls. The focus is on providing the most useful information to users and not reflecting the legal form. Inter-group transactions will be eliminated.

The Board discussed extensively what is meant by control. The Board tentatively concluded that control exists if the reporting entity has the ability to control the decision making within the enterprise. An equity shareholding is not necessarily needed for control to exist. Control can be established by way of a management contract. The Board was supportive of a definition of control that is similar to the one in IAS 27, with the wording changed slightly to reflect the ability to control rather than the power to control.

The Board discussed some examples. If A owns B, but C has options to acquire all of A's shares in B, then C has the ability to control B and must consolidate B even if the option as have not actually been exercised. In this case A is seen as an agent for C.

If severe restrictions on control are in place, the Board agreed that control is removed from the reporting entity. This can happen in circumstances such as bankruptcy (an EITF decision deals with this issue) or government restrictions being in force (in countries like Arabia). In South America, there is a requirement in some countries for more than 50% of the shares to be held locally - this would not, by itself, indicate control.

Paper B - comments received on SIC-12

The scope of the new IFRS should be wider than just SPEs. The board talked about a concept of 'Control so as to benefit'.

The Board wants to produce one IFRS with the same principles applicable to all. Separate rules will not be produced for SPEs, but the IFRS will include a list of indicators of the ability to control. This will include benefits received that indicate control, which are more relevant to SPEs. If a reporting entity has the majority of the risk and benefits, then the SPE must be consolidated.

Paper C - issues arising on the FASB draft Interpretation

In the United States, FASB has issued an exposure draft of an Interpretation on Consolidation of Special Purpose Entities. The Board broadly agreed with the principles in the FASB draft Interpretation. However they wanted to change the definition of control to be more like that of IAS 27. The FASB draft included 3 proposed exceptions for:

  • Entities that are consolidated by a substantive operating entity,
  • 'Qualifying' SPEs as defined in FAS 140, and
  • SPEs that hold certain financial assets.
The Board tentatively concluded that there should be no exceptions and the same principles should apply to all entities. The Board then discussed some specific examples to ensure they all agreed on when we should or should not consolidate an SPE.

Example: Company A gave assets to an SPE in exchange for some cash and a fee used to extract profits from the SPE. The SPE has an asset manager and an insurance policy and is financed by bank debt. Company A should consolidate this SPE even though it has no equity shareholding as it has the ability to control the SPE by extraction of profits.

Where there are debt and equity shareholders, consolidation should be on a basis of the risks and benefits.

The Board acknowledged that consolidation decisions are often not clear cut. The overall substance of the intercompany relationship must be considered.

The meeting ended with the project manager agreeing to develop a framework and set of criteria for the consolidation process that would be discussed at the next meeting with the National Standard Setters.

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