• an obligation to act in the best interest of those who have delegated the power
does not prevent the decision-maker from being a principal.
The terms and conditions of the arrangement are considered to assess whether an entity
is an agent or a principal. The determination of whether a decision-maker is an agent
or a principal is made based on the following:
• scope of decision-making authority;
• rights held by other parties (e.g. existence of removal rights);
• remuneration of the decision-maker; and
• exposure to variability of returns through other interests. [IFRS 10.B60].
Each of these factors is discussed in more detail below. When reaching a conclusion,
each of the factors is weighted according to the facts and circumstances of each case,
[IFRS 10.B60], which will require judgement. The only situation that is conclusive by itself
is when removal rights are held by a single investor and the decision-maker can be
removed without cause. [IFRS 10.B61]. This is discussed in more detail at 6.3 below.
Accordingly, although each of the factors are discussed in isolation below, a conclusion
should be based on all of the factors considered together. Of the four factors that need
to be considered when assessing whether the decision-maker is acting as principal or
agent, generally it will be the rights held by third parties to remove the decision-maker
(see 6.3 below) and the exposure to variability of returns (see 6.5 below) that will require
careful consideration.
Consolidated financial statements 419
Principal?
Agent?
Decision-
maker
6.2
Scope of decision-making
To assess whether a decision-maker is a principal or an agent, the scope of its authority
is evaluated by considering both:
• the activities that the decision-maker is permitted to direct (e.g. by agreement or
by law); and
• the discretion that the decision-maker has when making decisions about those
activities. [IFRS 10.B62].
It is implicit in the definition of control that, for a decision-maker to control the entity
over which it has been delegated decision-making authority, the decision-maker must
have power. This means that it must have been delegated the rights that give the current
ability to direct the relevant activities (the activities that most significantly affect that
investee’s returns). If a decision-maker has been delegated rights that do not relate to
the relevant activities, it would not have control over the investee.
For this reason, it is imperative to understand the purpose and design of the investee,
the risks to which it was designed to be exposed and the risk it was designed to pass
on to the other parties involved. Understanding the purpose and design of the
investee often helps in assessing which rights were delegated, why they were
delegated, and which rights have been retained by other parties, and why those
rights were retained.
6.2.1
Involvement in design
IFRS 10 requires that a decision-maker considers the purpose and design of the
investee, the risks to which the investee was designed to be exposed, the risks it was
designed to pass on to the parties involved and the level of involvement the decision-
maker had in the design of an investee. For example, if a decision-maker is significantly
involved in the design of the investee (including in determining the scope of decision-
making authority), that involvement may indicate that the decision-maker had the
opportunity and incentive to obtain rights that result in the decision-maker having the
ability to direct the relevant activities. [IFRS 10.B63].
However, a decision-maker’s involvement in the design of an investee does not mean
that decision-maker necessarily is a principal, even if that involvement was significant.
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A decision-maker is a principal if it is not primarily engaged to act on behalf of and for
the benefit of others. This determination is made in the context of considering the
purpose and design of the investee, and the other factors listed at 6.1 above. While not
determinative, a decision-maker’s involvement in the design of an investee is part of the
context when concluding if it is a principal or agent.
In our view, similar to the considerations for structured entities discussed at 4.6
above, when a decision-maker sponsors an investee, and establishes certain
decisions in the governing documents of the investee, there should be increased
scrutiny as to whether that decision-maker is a principal or an agent with respect
to the investee, particularly if the other factors are indicative of the decision-
maker being a principal. However, when there are many parties involved in the
design of an investee, the decisions established in the governing documents might
be less relevant.
6.2.2
Assessing whether the scope of powers is narrow or broad
When evaluating whether a decision-maker is a principal or an agent, in considering
the scope of its decision-making authority, it appears that a relevant factor is
whether the scope of powers that have been delegated (and the discretion allotted)
is narrow or broad. In an example in IFRS 10 where a decision-maker (fund
manager) establishes, markets and manages a publicly traded, regulated fund
according to narrowly defined parameters set out in the investment mandate, it is
stated that this is a factor that indicates that the fund manager is an agent.
[IFRS 10.B72 Example 13]. In another example, where the decision-maker (fund manager)
has wide decision-making authority, it is implied that the extensive decision-making
authority of the fund manager would be an indicator that it is a principal.
[IFRS 10.B72 Example 14-14A]. This suggests that where the scope of powers is broad, this
would be an indicator that the decision-maker is a principal. However, to conclude
whether a decision-maker is an agent or a principal, the scope of power needs to be
evaluated with the other three factors in totality.
6.3
Rights held by other parties
The decision-maker may be subject to rights held by other parties that may affect
the decision-maker’s ability to direct the relevant activities of the investee, such as
rights of those parties to remove the decision-maker. Rights to remove are often
referred to as ‘kick-out’ rights. Substantive removal rights may indicate that the
decision-maker is an agent. [IFRS 10.B64]. Liquidation rights and redemption rights
held by other parties, which may in substance be similar to removal rights, are
discussed at 6.3.2 below.
Other substantive rights held by other parties that restrict a decision-maker’s discretion
are considered similarly to removal rights when evaluating whether the decision-maker
is an agent. For example, a decision-maker that is required to obtain approval from a
small number of other parties for its actions is generally an agent. [IFRS 10.B66].
Consolidated financial statements 421
Figure 6.6:
Evaluating rights to remove without cause
Number of parties
Indicator that a
&nbs
p; holding removal right
decision maker is
Always an agent
One party
Generally an agent
A small number of parties
or an independent board
A principal
Many parties
As shown in the diagram above, when a single investor holds substantive rights to
remove the decision-maker without cause, that fact in isolation is sufficient to conclude
that the decision-maker is an agent. [IFRS 10.B65]. That is, the decision-maker does not
consolidate the entity.
However, if multiple investors hold such rights (i.e. no individual investor can remove the
decision-maker without cause without the others), these rights would not, in isolation,
determine whether a decision-maker is an agent or a principal. That is, all other facts and
circumstances would need to be considered. The more parties that must act together to
remove a decision-maker and the greater the magnitude of, and variability associated
with, the decision-maker’s other economic interests, the less weighting that is placed on
the removal right. [IFRS 10.B65]. This is reflected in an example provided by IFRS 10 where
there is a large number of widely dispersed unrelated third party investors. Although the
decision-maker (the asset manager) can be removed, without cause, by a simple majority
decision of the other investors, this is given little weighting in evaluating whether the
decision-maker is a principal or agent. [IFRS 10.B72 Example 15].
If an independent Board of Directors (or governing body), which is appointed by the other
investors, holds a right to remove without cause, that would be an indicator that the
decision-maker is an agent. [IFRS 10.B23(b), B67]. This is the position taken in an example in
IFRS 10 (see Example 6.31 at 6.6 below) where a fund has a Board of Directors, all of
whose members are independent of the decision-maker (the fund manager) and are
appointed by the other investors. The Board of Directors appoints the fund manager
annually. The example explains that the Board of Directors provides a mechanism to
ensure that the investors can remove the fund manager if they decide to do so.
422 Chapter
6
6.3.1
Evaluating whether a removal right is substantive
When evaluating removal rights, it is important to determine whether they are substantive,
as discussed at 4.2.1 above. If the removal right is substantive, this may be an indicator that
the decision-maker is an agent. [IFRS 10.B64]. On the other hand, if the removal right is not
substantive, this may be an indicator that the decision-maker is a principal, but this
indicator should be given less weight. The determination of whether the decision-maker
is a principal needs to be based on the three other factors, i.e. scope of decision-making
authority, remuneration and exposure to variability of returns through other interests.
Some of the criteria that might be more relevant when evaluating whether a removal
right is substantive are shown in the diagram below. However, all of the factors noted
at 4.2.1 above and IFRS 10 must be considered in this evaluation.
Figure 6.7:
Evaluating whether removal rights are substantive
Non-substantive
Substantive right
right
Exercisable only
Exercisable
for cause
without cause
Significant
Insignificant
financial penalty
financial penalty
to exercise
to exercise
Several other
Skills held by
parties could
decision- maker
fulfil role of
are unique
decision-maker
Not currently
Currently
exercisable
exercisable
Principal
Agent
Decision-
maker
Evaluating whether a removal right is substantive will depend on facts and
circumstances. [IFRS 10.B23].
6.3.1.A Available
replacements
When evaluating whether a removal right is substantive, consideration is given as to whether
suitable replacements exist. This is because if there are no (or few) suitable replacements for
the decision-maker, this would be an operational barrier that would likely prevent the parties
holding the removal right from exercising that removal right. [IFRS 10.B23(a)(vi)].
In the asset management industry, suitable replacements are generally available.
However, in other industries (e.g. construction, real estate, extractive), it is more
common for the decision-maker to possess unique traits. For example, the decision-
maker may have experience with a particular geographic location, local government, or
Consolidated financial statements 423
proprietary intellectual property or tools. That might make it more difficult to assess
whether there are other parties that could replace the decision-maker if the parties
wanted to remove the decision-maker. However, regardless of the industry, an
assessment of whether there are available replacements depends upon the specific facts
and circumstances, and will require judgement.
6.3.1.B Exercise
period
A removal right may not be exercisable until a date in the future. In such cases,
judgement must be exercised to determine whether (or when) that right becomes
substantive. Similarly, when a removal right can only be exercised during a narrow
period (e.g. for one day on the last day of the reporting period), judgement is necessary
to determine whether the right is substantive.
When a removal right is exercised, there is typically a period (e.g. six months) until the
decision-maker transitions decision-making back to the principal (or to another
decision-maker) in an orderly manner. In such cases, judgement will be required to
assess whether the principal has the current ability to direct the relevant activities when
decisions need to be made, and therefore whether the removal right is substantive.
In our view, even if there is a transition period between when the decision-maker is
removed and when the principal (or another decision-maker) becomes responsible for
making decisions, the removal right may still be substantive.
6.3.2
Liquidation rights and redemption rights
In some cases, rights held by other parties (such as some liquidation rights and some
redemption rights) may have the same effect on the decision-maker’s authority as
removal rights. When a liquidation right or a redemption right is in substance the same
as a removal right, its consideration in the evaluation of whether a decision-maker is a
principal or an agent is the same.
For example, if a limited partnership were required to be liquidated upon the
withdrawal of one limited partner, that would be considered a removal right if it were
substantive (as discussed at 4.2.1 and 6.3.1 above). However, such rights must be
analysed carefully, based on the facts and circumstances.
6.4 Remuneration
The third factor to evaluate when assessing whether a decision-maker is a principal or
an agent is remuneration.
The greater the magnitude
of, and variability associated with, the decision-maker’s
remuneration relative to the returns expected from the activities of the investee, the
more likely the decision-maker is a principal. [IFRS 10.B68]. Therefore, when
determining if a decision-maker is a principal or an agent, the magnitude and
variability of exposure to returns through remuneration are always considered. This
applies even if the remuneration is at market rates. However, as discussed at 6.4.1
below, IFRS 10 does not include any examples of remuneration arrangements where
it is clear the remuneration is of such significance that it, in isolation, indicates that
the decision maker is a principal.
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6
In determining whether it is a principal or an agent the decision-maker also considers
whether the following conditions exist:
(a) The remuneration of the decision-maker is commensurate with the services provided.
(b) The remuneration agreement includes only terms, conditions or amounts that are
customarily present in arrangements for similar services and level of skills
negotiated on an arm’s length basis. [IFRS 10.B69].
IFRS 10 states that a decision-maker cannot be an agent unless the conditions set out in
(a) and (b) above are present. However, meeting those conditions in isolation is not
sufficient to conclude that a decision-maker is an agent. [IFRS 10.B70].
6.4.1
Evaluating remuneration in the asset management industry
When evaluating whether a decision-maker is a principal or an agent, an entity is
required to evaluate the magnitude and the variability of the remuneration relative to
the expected returns from the investee. In examples related to the asset management
industry, IFRS 10 describes three common remuneration structures:
• 1% of net assets under management; [IFRS 10.B72 Example 13]
• 1% of assets under management and performance-related fees of 10% of profits if
the investee’s profits exceed a specified level; [IFRS 10.B72 Example 15] and
• 1% of assets under management and 20% of all the fund’s profits if a specified profit
level is achieved. [IFRS 10.B72 Example 14].
In each case, the examples assume that the remuneration is commensurate with the
services provided. In addition, the remuneration aligns the interests of the decision-maker
with those of other investors. However, IFRS 10 concludes for each of these cases that
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 84
