An investor holds an option to acquire the majority of shares in the investee, which is not currently
exercisable. However, the option is exercisable before the next scheduled shareholder meeting, and before
the next special shareholder meeting could be held (based on the investee’s governance policies).
When considering solely the exercise period, the investor’s option would be a substantive right that gives the
investor power (since it would give the holder a majority of shares). This is because the investor does have
the current ability to direct the investee’s relevant activities when decisions need to be made, i.e. at the next
scheduled shareholder meeting or next special shareholder meeting.
However, when concluding whether an investor has power over the investee in real fact patterns, all relevant facts
and circumstances would be considered, to evaluate whether the option is substantive, not solely the exercise period.
In contrast, if the next shareholders’ meeting occurs (or could be held) before the option
is exercisable, that option would not be a right that would give the holder the current
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ability to direct the investee’s activities (and therefore would not give the holder power).
This is consistent with the conclusion for Scenario D in Example 6.7 at 4.2.1 above.
IFRS 10 does not contain separate requirements for different types of potential voting
rights; that is, employee options are subject to the same requirements as those that are
held by a third party. However, it would be unlikely that an option held by an employee
would give that employee power (or control) over an investee in practice, usually
because the employee options represent a small percentage of the outstanding shares,
even if exercised. However, in a very small, privately owned entity it would be possible
for an employee (such as a member of management) to have power, if an option gives
the employee the current ability to direct the relevant activities, or if the employee has
other interests in the investee.
It should be noted that the IASB considered, but did not change, similar requirements
in IAS 28 related to how options are considered when evaluating whether an investor
has significant influence. That is, IAS 28 does not incorporate the IFRS 10 concept of
evaluating whether an option is substantive (see Chapter 11 at 4.3). Accordingly, an
option might give power under IFRS 10, but the same option might not result in
significant influence under IAS 28.
Simply holding a currently exercisable option that, if exercised, would give the investor
more than half of the voting rights in an investee is not sufficient to demonstrate control
of the investee. All facts and circumstances must be considered to assess whether an
investor has power over an investee, including whether an option is substantive
(including, but not limited to consideration of the exercise period). This may require
considerable judgement to be exercised.
4.3.5
Contractual arrangement with other vote holders
A contractual arrangement between an investor and other vote holders can give the
investor the right to exercise voting rights sufficient to give the investor power, even if
the investor does not have voting rights sufficient to give it power without the
contractual arrangement. However, a contractual arrangement might ensure that the
investor can direct enough other vote holders on how to vote to enable the investor to
make decisions about the relevant activities. [IFRS 10.B39].
It should be noted that the contractual arrangement has to ensure that investor can
direct the other party to vote as required. Where the arrangement is merely that the
parties agree to vote the same way, that would only represent joint control; defined
as the contractually agreed sharing of control of an arrangement, which exists only
when decisions about the relevant activities require the unanimous consent of the
parties sharing control. [IFRS 11 Appendix A]. Joint control is discussed in more detail in
Chapter 12 at 4.
In some jurisdictions, investors holding a certain number of issued shares of a public
company may be able to obtain proxy votes from other shareholders by public request
or other means for voting at shareholder meetings. The question as to whether the
investor has the ability to obtain a majority of votes (and hence power over an investee)
through control of proxy votes will depend on the specific facts and circumstances of
the process such as, for example, the investor’s freedom to use the proxy vote and
whether any statements of voting intent must be provided by the investor as a condition
Consolidated financial statements 405
of obtaining the proxy vote. A situation where, for example, proxies must be requested
each year would make it more difficult to demonstrate that the investor had power as a
result of its ability to obtain proxy votes.
4.3.6
Additional rights from other contractual arrangements
Other decision-making rights, in combination with voting rights, can give an investor
the current ability to direct the relevant activities. For example, the rights specified
in a contractual arrangement in combination with voting rights may be sufficient to
give an investor the current ability to direct the manufacturing processes of an
investee or to direct other operating or financing activities of an investee that
significantly affect the investee’s returns. However, in the absence of any other
rights, economic dependence of an investee on the investor (such as relations of a
supplier with its main customer) does not lead to the investor having power over the
investee. [IFRS 10.B40].
Example 6.18 below reflects an example from IFRS 10 of a situation where an investor
with less than a majority of the voting rights is considered to have power of the investee,
taking into account rights under a contractual arrangement. [IFRS 10.B43 Example 5].
Example 6.18: Less than a majority of voting rights combined with additional
rights under a contractual arrangement
Investor A holds 40% of the voting rights of an investee and twelve other investors each hold 5% of the voting
rights of the investee. A shareholder agreement grants investor A the right to appoint, remove and set the
remuneration of management responsible for directing the relevant activities. To change the agreement, a
two-thirds majority vote of the shareholders is required. In this case, investor A concludes that the absolute
size of the investor’s holding and the relative size of the other shareholdings alone are not conclusive in
determining whether the investor has rights sufficient to give it power. However, investor A determines that
its contractual right to appoint, remove and set the remuneration of management is sufficient to conclude that
it has power over the investee. The fact that investor A might not have exercised this right or the likelihood
of investor A exercising its right to select, appoint or remove management shall not be considered when
assessing whether investor A has power.
4.4 Contractual
arrangements
Power stems from existing rights. Sometimes, the relevant activities are not directed
through voting rights, but rather, are directed by other means, such as th
rough one or
more contractual arrangements. [IFRS 10.11]. For example, an investor might have the
contractual ability to direct manufacturing processes, operating activities, or determine
financing of an investee through a contract or other arrangement.
Similarly, when voting rights cannot have a significant effect on an investee’s returns,
such as when voting rights relate to administrative tasks only and contractual
arrangements determine the direction of the relevant activities, the investor needs to
assess those contractual arrangements in order to determine whether it has rights
sufficient to give it power over the investee. To determine whether an investor has
rights sufficient to give it power, the investor considers the purpose and design of the
investee (see paragraphs B5-B8 of IFRS 10 discussed at 3.2 above) and the
requirements in paragraphs B51-B54 (discussed below) together with paragraphs B18-
B20 (see 4.5 below). [IFRS 10.B17].
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6
When these contractual arrangements involve activities that are closely related to the
investee, then these activities are, in substance, an integral part of the investee’s overall
activities, even though they may occur outside the legal boundaries of the investee.
Therefore, explicit or implicit decision-making rights embedded in contractual
arrangements that are closely related to the investee need to be considered as relevant
activities when determining power over the investee. [IFRS 10.B52].
When identifying which investor, if any, has power over an investee, it is important to
review the contractual arrangements that the investor and the investee entered into.
This analysis should include the original formation documents and governance
documents of the investee, as well as the marketing materials provided to investors and
other contractual arrangements entered into by the investee.
It is common that the relevant activities of a structured entity are directed by contractual
arrangement. This is discussed further at 4.4.1 below.
4.4.1 Structured
entities
IFRS 12 defines a structured entity as an entity that has been designed so that voting
or similar rights are not the dominant factor in deciding who controls the entity,
such as when any voting rights relate to administrative tasks only and the relevant
activities are directed by means of contractual arrangements. [IFRS 12 Appendix A].
Therefore, an entity that is controlled by voting rights is not a structured entity.
Accordingly, although it might be thought that an entity that receives funding from
third parties following a restructuring is a structured entity, this would not be the
case, if that entity continues to be controlled by voting rights after the restructuring.
[IFRS 12.B24].
A structured entity often has some or all of the following features:
• restricted activities;
• a narrow and well-defined objective, such as:
• holding a tax-efficient lease;
• carrying out research and development activities;
• funding an entity; or
• providing investment opportunities for investors by passing on risks and
rewards associated with assets to investors;
• insufficient equity to finance its activities without subordinated financial support;
and
• financing in the form of multiple contractually-linked instruments to investors that
create concentrations of credit or other risks (tranches). [IFRS 12.B22].
Examples of structured entities include:
• securitisation vehicles;
• asset-backed financings; and
• some investment funds. [IFRS 12.B23].
Consolidated financial statements 407
Management needs to evaluate whether it controls a structured entity using the same
approach as for ‘traditional entities’ (those that are controlled through voting rights). That
is, management evaluates whether an investor has power over the relevant activities,
exposure to variable returns and the ability to affect those returns through its power over
the structured entity, as shown in the diagram at 3.1 above. Frequently, as discussed above,
the relevant activities of a structured entity are directed by contractual arrangement.
For some investees, relevant activities occur only when particular circumstances arise
or events occur. The investee may be designed so that the direction of its activities and
its returns are predetermined unless and until those particular circumstances arise or
events occur. In this case, only the decisions about the investee’s activities when those
circumstances or events occur can significantly affect its returns and thus be relevant
activities. The circumstances or events need not have occurred for an investor with the
ability to make those decisions to have power. The fact that the right to make decisions
is contingent on circumstances arising or an event occurring does not, in itself, make
those rights protective. [IFRS 10.B53].
This is illustrated in Example 6.19 below, which is summarised from an example
included in IFRS 10. [IFRS 10.B53 Example 11].
Example 6.19: Power through contractual arrangements
An investee’s only business activity, as specified in its founding documents, is to purchase receivables and
service them on a day-to-day basis for its investor. The servicing includes collecting the principal and interest
payments as they fall due and passing them on to the investor. For any receivable in default, the investee is
required to automatically put the receivable in default to the investor, as contractually agreed in the put
agreement between the investor and the investee.
The relevant activity is managing the receivables in default because it is the only activity that can significantly
affect the investee’s returns. Managing the receivables before default is not a relevant activity because it does
not require substantive decisions to be made that could significantly affect the investee’s returns – the
activities before default are predetermined and amount only to collecting cash flows as they fall due and
passing them on to investors.
The purpose and design of the investee gives the investor decision-making authority over the relevant activity.
The terms of the put agreement are integral to the overall transaction and the establishment of the investee.
Therefore, the put agreement, together with the founding documents of the investee, gives the investor power
over the investee. This is the case, even though:
• the investor takes ownership of the receivables only in the event of default; and
• the investor’s exposures to variable returns are not technically derived from the investee (because the
receivables in default are no longer owned by the investee and are managed outside the legal boundaries
of the investee).
To conclude whether the investor has control, it would also need to assess whether the other two criteria are
met, i.e. it has exposure to variable returns from its involvement with the investee (see 5 below) and the ability
to use its power over the investee to affect the amount of its returns (see 6 below). [IFRS 10.7, B2].
IFRS 10 also includes a much simpler example where the only assets of an investee are
receivables and when the purpose and design of the inve
stee are considered, it is
determined that the only relevant activity is managing the receivables upon default. In
this situation, the party that has the ability to manage the defaulting receivables has
power over the investee, irrespective of whether any of the borrowers have defaulted.
[IFRS 10.B53 Example 12].
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6
An investor may have an explicit or implicit commitment to ensure that an investee
continues to operate as designed. Such a commitment may increase the investor’s
exposure to variability of returns and thus increase the incentive for the investor to
obtain rights sufficient to give it power. Therefore a commitment to ensure that an
investee operates as designed may be an indicator that the investor has power, but does
not, by itself, give an investor power, nor does it prevent another party from having
power. [IFRS 10.B54].
Notwithstanding the fact that the same approach is used to evaluate control for
structured entities and traditional entities, it is still important to identify which entities
are structured entities. This is because certain disclosure requirements of IFRS 12 apply
only to structured entities, as discussed in Chapter 13.
4.5
Other evidence of power
In some circumstances, it may be difficult to determine whether an investor’s rights give
it power over an investee. In such cases, the investor considers other evidence that it has
the current ability to direct an investee’s relevant activities unilaterally. Consideration is
given, but is not limited, to the following factors, which, when considered together with
its rights, the indicators of a special relationship with the investee and the extent of the
investor’s exposure to variability of returns (see below), may provide evidence that the
investor’s rights are sufficient to give it power over the investee:
• the investor can, without having the contractual right to do so, appoint, approve or
nominate the investee’s key management personnel (or Board of Directors) who
have the ability to direct the relevant activities;
• the investor can, without having the contractual right to do so, direct the
investee to enter into, or veto any changes to, significant transactions for the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 81
