A recent change to the Australian Accounting Standards (AASB) will redefine the concept of control for many entities.
AASB 10 – Consolidated Financial Statements will replace AASB 127 – Consolidated and Separate Financial Statements and Interpretation 112 Consolidation – Special Purpose Entities and will apply to annual reporting periods beginning on or after 1 January 2013.
The new accounting standard provides additional guidance on determining whether control exists over an entity and, consequently, whether it should be consolidated.
The method for defining control will require those who prepare financial reports to exercise significant judgement. For many entities this assessment will be very complex and we encourage the preparers of financial reports to discuss the issues with their auditors.
The accounting standard provides a model for determining an investor’s control based on three elements:
Power over the investee
An investor has power over an investee when it has existing rights that give it the ability to direct relevant activities (activities that significantly affect the investee’s returns.) It is generally accepted that power arises from these rights, regardless of whether they are exercised, provided they are currently exercisable.
In the context of determining control, only substantive rights are considered. That is, the investor must have the practical ability to exercise the rights and the rights must not have been assigned only to protect the interests of the holder.
In some cases, the assessment of power can be straight forward, for example, where an investor has more than 50% of the voting rights. In other situations, the assessment of power will be more complex and will require consideration of more than one factor, such as when power arises as a result of a contractual arrangement.
Exposure or rights to variable returns from its involvements with the investee
An investor is exposed, or has rights, to variable returns from its involvement with the investee when the investor’s returns have the potential to vary as a result of the investee’s performance.
Although only one investor can control an investee, more than one party can share in the returns of an investee. For example, holders of non-controlling interests can share in the profits or distributions of an investee.
The ability for the investor to use its power over the investee to affect the amount of the investor’s returns
Even with power and exposure or rights to variable returns, an investor may not be considered to have control over the investee.
For the investor to control an investee, it must have the ability to use its power to affect the amount of returns. The link between power over an investee and exposure or rights to variable returns from involvement with the investee is essential to having control.
Control is assessed on a continuous basis. An investor is required to reassess whether it controls an investee if the facts and circumstances indicate that there are changes to one of the three elements of the control model.
It is possible for an entity to ‘flip in and out’ of a group between reporting periods.
New processes may be required to gather the information necessary to make judgements and to comply with required disclosures. Further, if not already provided by regulatory requirements, management may wish to consider requiring notice of changes in investors (or other significant events that could trigger changes in control) when entering into new arrangements.
For more information on how the new control model may impact the structure of your group please contact your local William Buck office.