Staff draft of ED

The Board discussed an updated Staff Draft of the forthcoming Consolidation exposure draft. The draft incorporates comments received at the Board meeting of 2 October as well as other comments received. The staff noted the following changes in particular:

• references to 'beneficial interests' had been removed;
• the 'power and benefits' discussion were moved from the application guidance to the main body of the draft IFRS, and integrated with the characteristics of control;
• the section on structured entities had been rewritten;
• disclosure requirements had been added.

Several Board members were sympathetic to what the staff was trying to achieve, but remained unconvinced that the proposed approach was operational. In particular, the drafting was seen as very subjective. In addition, some thought that the section addressing structured investment vehicles (in particular paragraph 43) might result an entity being able to derecognise assets but, because there was a financing relationship with the entity because the entity continued to sell receivables to the structured entity, the structured entity would continue to be consolidated (that is, through the sale of receivables the structured entity provides 'a source of long-term financing' to the entity).

The discussion of 'benefits' (paragraphs 23-27) also attracted comment. In particular, the staff noted that the IASB draft uses 'benefit' to imply both positive and negative returns. Several Board members noted that many readers would not expect that result; 'benefits' is usually used to describe positive returns only (and US GAAP uses 'benefit' in this way). In addition, 'risk' is used to imply negative returns. Professor Barth noted that academics see 'risk' as addressing both positive and negative returns: risk is both variance and outcomes above and below the mean. However, the Board agreed that the drafting should be amended such that it did not suggest that the IASB was unaware of finance literature and research, as well as avoiding creating unintended differences between IFRS and US GAAP. The Board asked the staff to re-order the discussion in paragraphs 23-27 and search for a word or phrase that could be used instead of 'benefits'.

The Board also suggested that the general principle of control ('A reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity for the benefit of the reporting entity') needed re-wording (or perhaps a footnote) to explain that it encompassed the reporting entity, it agents or related parties.

The Board discussed the characteristics of control, in particular the concept that control must be current for consolidation to be required (paragraphs 10-14). Some were concerned that the discussion of predetermination was not sufficient to capture the Board's intent with respect to structured entities. Another issue in this section was the effect of options. A Board member expressed his view that in-the-money options can create control, but acknowledges that this creates an inconsistency between 'ordinary' inter-corporate investments and structured entities.

The Board debated this issue for a while. Most of the debate centred on whether holding such an option established a presumption of control, triggering consolidation. However, late in the debate a Board member asked whether an entity writing a put option for the whole of its holding in a subsidiary would trigger a loss of control and thus cessation of consolidation? Board members thought this was a very good question.

The Chairman closed this part of the debate by reminding his colleagues that the staff needed direction from the Board on this issue. The Board was asked whether the exposure draft should state that in assessing whether an entity controls another at the reporting date options that represent a current legal right and that the holder can exercise should be considered in that assessment. The Board agreed (one dissent) that such options should be assessed.

Board members and the project staff discussed how best to structure the exposure draft such that the Board's intent that the assessment of whether control exists should be an holistic assessment, rather than a linear assessment or checklist. One suggestion was to re-cast the general principle such that 'control should be current, not shared and continuous' and then elaborate on that principle in the supporting paragraphs. The staff will work on this out of session.

The Board discussed paragraph 53(c), which proposes disclosure of 'the nature of and risks associated with its involvement with structured entities that it does not control'. One Board member was particularly concerned that users should know the 'leverage' of the first loss in a structured entity and asked how this could be articulated in the disclosure requirements. The Chairman asked the staff to review the guidance in IAS 27 and SIC-12 to ensure that nothing the Board intends to retain had been omitted from the exposure draft.

In addition, a Board member suggested that the project staff should review the structured entity examples in the proposed FASB Interpretation 46(R) and provide their view on whether the consolidation conclusions were consistent with the US answers. The staff noted that this work had been started and was progressing as quickly as possible. The Board member suggested that this analysis should be included in the exposure draft as an appendix as constituents would expect to see it.