Consolidation – Including Special Purpose Entities

Date recorded:

Over the past few months IASB staff have been analysing financial statements, meeting with representatives from investment banks and accountancy firms and assessing statements from regulators about what they perceive to be good practice and good disclosure relating to consolidation. The purpose of this session was to provide the Board with an overview of this analysis and to describe how the staff expects this analysis to translate into new proposals to replace IAS 27 Consolidated and Separate Financial Statements and SIC 12 Consolidation - Special Purpose Entities.

The IASB staff introduced Agenda Paper 8A and indicated that the issues relating to consolidation also encompassed disclosures around securitisations, for example, those in IFRS 7. As a consequence, the project is also likely to result in change to disclosure requirements.

The underlying issue that the project is attempting to address is the potential conflict between the requirements of IAS 27 and SIC-12, with the ultimate goal of producing a single model of control as an approach to the consolidation of all entities.

The staff the introduced a diagram representing a framework for the questions and issues being resolved as part of the project (copied below from Agenda Paper 8A, paragraph 17):

One Board member noted that the term 'critical accounting policy' was misleading as consolidation is not an accounting policy; rather it is a question of fact whether an entity controls another entity. The point was noted by staff and it was clarified that the staff intended the statement to mean that there was a requirement to make a judgement. The staff also clarified that joint control is not intended to be part of this project as the focus of the project is on consolidation; however, the project team does meet with the project team dealing with joint arrangements on a regular basis.

The staff highlighted that the focus of the project was on consolidation (right hand side of the diagram) rather than anything on the left hand side of the diagram. However, the staff also clarified that they were not ignoring the other aspects and consideration may also be relevant as part of the project, in particular relating to disclosure. One Board member added that disclosure is an essential part of the project to solve the overall problem. Just focusing on the top right box does not solve the problem as the Board needs to come to a coherent solution. A Board member suggested this was an expansion of the consolidation project. Another Board member noted that the Board didn't want to lose focus on this project.

The Board then moved on to discuss specific aspects of the agenda paper. One Board member highlighted that some of the disclosures suggested in the paper were simply segment information from a legal entity focus. Some other Board members agreed.

Another Board member then suggested that the focus of the project is on whether an entity should consolidate or not, that is, the application of control. A second Board member added that the biggest question the Board needs to answer is around consolidation, but they also need to consider disclosure; in particular, the Board needs to decide what to do about significant involvement and possible involvement. The staff responded to this suggestion by clarifying that the term significant involvement is merely a descriptor, not a category. It was not the intention of the staff to redefine anything. The staff also noted that it is important to understand the effect the legal structure have on the overall group, for example, whether there are any restrictions over use of assets. The question that may need to be addressed is whether the Board currently has the right level of detail in IFRS 7. The staff then moved on to explain their working definition of control:

A reporting entity controls another entity when it has sufficient rights that it has the power to be able to use or manage the assets and liabilities of that entity as if they are its own. That power must give the reporting entity the ability to affect the financial variability of the entity and the benefits from, or exposure to, that financial variability.

The staff also introduced the working principles on which this definition is based:

  • a. Only one party can control an entity. The party that controls an entity is able to exclude others from using or managing the assets and liabilities of that entity and from the related benefits.
  • b. Assessing whether a reporting entity controls another entity is a continuous process. A reporting entity begins consolidating the financial statements of another entity with its own financial statements when it achieves control and ceases consolidation when it loses control
  • c. Control refers to the 'present ability' to control another entity; it is not based on whether the reporting entity controlled yesterday or might control tomorrow.

It was noted by one Board member that in many circumstances an entity would not know if another entity is claiming to have control over a subsidiary. So, it is not possible to always avoid the scenario where two entities claim control over a subsidiary.

The Board then discussed some of the consequences of the principles highlighted by the staff. It was noted that there were some apparent inconsistencies in the consequences; for example, one consequence noted by the staff is 'A reporting entity does not control another entity if action must be taken for it to gain control. For example, holding an option or convertible instruments that would give the holder control if exercised is not the same as having control after exercise', whereas another consequence is noted as 'One entity's ability to terminate the activities of another entity for its own benefit (perhaps by having the right to acquire all assets of the entity at any time) is like to constitute control. It was noted by one Board member that the ability to terminate was like an option and therefore the two statements were in conflict. Further, the Board did not agree with the first consequence (relating to options), and the staff agreed that more work needed to be done in this area to clarify the consequences.

The staff indicated that they expect that the next due process document over the next few months. The staff expects to bring back the proposals to the Board as one complete package, rather than as piecemeal issues. The staff concluded the discussion by stating that the intention of the staff was to make the next due process document an exposure draft rather than a discussion paper. The Board agreed.

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